Waving The White Flag On Exela

Management is an important facet of every business, and as much as we like our bull case for Exela (NASDAQ:XELA), our additional due diligence has discovered a series of troubling red flags with the company, mainly regarding its largest shareholder, HandsOn Global management, that makes its stock uninvestable, even though we continue to believe in the bull case.

Take the contract with a grain of salt

We admit we screwed up completely on Exela, first by turning bullish when the stock was in the $4s, and then by turning neutral when the stock was near all-time lows.

Recently, Exela announced a major contract with General Dynamics (GD) that could provide up to $900 million over a 5-year time span, sending its stock up double-digit percent.

Even as the stock jumps significantly from its low, we are advising caution. The reason will be clear soon enough. But first, we’ll provide some background.

HandsOn Global Management is a private equity firm and is the majority owner of SourceHOV, which merged with Novitex to form Exela Technologies. It currently is the largest owner of Exela stock, owning nearly 60% of the shares outstanding.

Source: HandsOn website

Par Chadha is the CEO and CIO of HandsOn currently. HandsOn has a lot of power over Exela, getting to elect directors and with many of Exela’s executives being former SourceHOV staff.

He also happens to be the former CEO of Osicom, which was involved in significant controversy around its guidance and forecasting.

 

Osicom Technologies acknowledged Thursday that a contract it once estimated to be worth $90 million generated only $68,000 in revenue, a development that sent its stock plunging and raised fresh questions about the company’s credibility.

The Santa Monica-based computer networker had announced July 1 that an order for a personal data assistant device from an unidentified Japanese firm would bring in about $90 million over two years. The stock jumped more than 20% the next day.

However, Osicom now says it has received only $68,000 for “nonrecurring engineering expenses” and that it expects no additional payment. Further, the Asian division of Osicom that handled the product has been put up for sale, the company said.

Source: latimes

Yeah, this looks very similar to what happened with General Dynamics. The only difference is that General Dynamics is more reputable than an unidentified Japanese firm. However, it still raises the question – how much money is likely to be realized from this deal? If history is any indication, the money realized from this contract could be a lot lower than $900 million.

Osicom wasn’t the only time Par Chadha had been involved in controversy, however, as a detailed article by the WSJ noted that Par Chadha, along with partner Barry Witz, had been involved in companies like Scorpion Technology, whose offices had been raided by the FBI and had “engaged in massive fraud”, according to former employees, through the use of Reg S abuses, which allowed it to sell stock overseas at a discount.

The reason why we bring up past fraud is because the fraud raises questions about the optimization and restructuring expenses Exela is facing, the reduction of which is key to the bull case. Some investors have privately confided to us that they believe there could be normal operating expenses hidden within O and R expenses. In fact, this was the reason why Moody’s downgraded Exela, as adjusted FCF drops to near $0 if the O and R expenses are counted as operating expenses.

The past acts of Par Chadha raise questions regarding the credibility of Exela’s press releases regarding new contracts and also raises questions about whether O and R expenses are truly what they’re classified as. These questions render Exela too speculative for us to invest in, regardless of how appealing the bull case is.

SPACs have a controversial history

It’s not only Par Chadha that has a controversial history, but the whole idea of SPACs is quite controversial.

Jeffry Quinn, the CEO of Quinpario, which was used to form Exela, had at one point also listed another company called Jason Industries (OTC:JASN) by acquiring it using a SPAC.

JASN is now down over 90% from when it was first listed. This raises the question of whether Jeffry, who was a former mining and chemicals executive, really did his due diligence when looking for acquisitions for his SPACs.

The very nature of SPACs provides incentives to find a target as quickly as possible instead of looking for the best target, as investors get to pull out their money after a set period of time. This could be why most SPACs that get listed fall below their IPO price, according to the Wall Street Journal.

Bull case is still sound

Despite everything we’ve mentioned earlier, we still think the upside is enormous if the O and R charges fade after a few quarters like management expects.

The shares are probably still suitable for investors willing to invest in more speculative stocks which could have more upside, but for us, the past misdeeds of management make this stock uninvestable.

It looks like the market agrees with us to some extent, as the shares dropped over 7% yesterday after rising over 20% due to the contract.

If management, especially HandsOn, proves their conviction by buying shares or by taking some other action that increases credibility, perhaps by hiring an independent, talented executive, we would be willing to buy back our shares.

Takeaway

It pains us to sell Exela, considering we have followed the company for months and believe in the bull case, but the motives of management are important, and it’s hard to tell what HandsOn wants to do with Exela to be in the long term. Dishonest management could destroy shareholder value even if they are the largest shareholders; for example, by taking the company private at a bargain price, which HandsOn has considered doing.

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