Laughing Water Capital Sees Rimini Street (RMNI) As Undervalued

Rimini Street Inc (NASDAQ: RMNI) is a $342.10-million market cap provider of third-party enterprise software support services. Laughing Water Capital recently released its Q2 investor letter in which the hedge fund’s founder and manager Matthew Sweeney discussed its thesis on Rimini Street. The letter also included Sweeney’s thoughts on EZCORP. Sweeney is optimistic about Rimini Street and believes that the company will perform well in the coming years. Here is everything that Sweeney said about RMNI in the letter to investors.

RMNI is the idea that I prepared for Value X Vail, and I have included the slide deck with this email. In short, Rimini is in the business of providing third party maintenance for enterprise software. This is a defensive, counter-cyclical business with high normalized margins that has been growing very fast. However, at the moment and for the foreseeable future RMNI is subject to uncertainty tied to litigation brought by Oracle, who Rimini is effectively undercutting on price. In the past I have said that simple common sense is often an effective path toward value creation, but I am strongly of the view that relying on common sense with anything tied to the legal system is a mistake. However, digging past the headlines and viewing the accounting through the lens of common sense rather than GAAP suggests that Rimini is markedly undervalued even considering adverse legal outcomes, and there are situations where we could see multiples of our investment returned to us in a few years, as well as situations where Rimini could continue to compound our capital for much longer periods.

Importantly, we were able to establish our position at very low prices due to a wrinkle in the market, almost ensuring that in the short term we would be rewarded as well. RMNI reported earnings on May 10th, and the window for employee stock trading opened at that time. While there has been small buying by insiders, rank and file employees – many of whom have been with the company for 10+ years without an opportunity to monetize their stock – began to sell en masse. The timing is important here, because May 11th was the date of record for the rebalancing of the Russell indexes, which are market cap weighted, meaning that the indexes will need to buy more shares of bigger companies (for more on why this makes little sense, see our H1’17 letter). Following the Russell record date, shares continued to trade down more than 25%, at which point we began buying, knowing that 6 weeks after the record date, the index and its followers would be buyers of shares in an amount that was determined when the price of shares was 30+% higher. This is not a fool proof plan by any means as many indexers try to get in front of index adjustments, and the ultimate success of this investment will be judged a few years from now, but Rimini is illiquid, and since the window for employees to sell would be closing just as brainless index funds would be buying, there was an exploitable imbalance in supply and demand of which we were able to take advantage.

We own both common stock and SPAC warrants, both of which have appreciated by more than 30% in little more than a month. In my view, the SPAC warrants, which are essentially long dated options, are especially attractive. I don’t spend a lot of time trying to probability weight outcomes, but if one were to assume a 95% chance that the company goes to zero, and only a 5% chance that our upside target is met, mathematically, this would still be the right bet to make. In actuality, I think the chance that this company goes to zero is very small, and there are multiple ways that the warrants could return between 10x and 30x our invested capital in a few years. However, in the near term, they will be significantly more volatile than the market as they are levered securities. As always, I think that accepting short term volatility for the possibility of long term outsized returns is the right investment for a patient, long term partnership such as ours.

It should be noted that each of these investments is off to a good start, mostly because of temporary special situations that we were able to identify and exploit. Finding these temporary inefficiencies and taking advantage of them makes me feel how I imagine my 2 year old feels when he thinks he got another cookie without me noticing. However, these wrinkles should be viewed as the investing equivalent of a 20 yard head start in a sprint versus Usain Bolt. A 20 yard advantage is great, but you still have to be significantly faster than the average person to ensure victory. Just as the winner of the race will be determined not by one’s starting position but rather by one’s speed, our ultimate success with these investments will depend on the unique attributes of each business and its management team in the years to come. It is entirely possible that we will give back our recent gains in the near term before realizing significantly greater gains in the years to come.

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Last week, Rimini Street Inc (NASDAQ: RMNI) reported financial results for its second quarter ended June 30, 2018. The company had revenue of $62.6 million for the quarter, up 20% compared to $52.0 million for the same quarter of 2017. Annualized Subscription Revenue was about $246 million for the quarter, an increase of 18% compared to $208 million in 2017. The company posted a net loss of $25.4 million, or a loss of $0.43 per share, compared to a net loss of $25.9 million, or a loss of $1.05 per share, for the same quarter last year.

RMNI shares are down 23.97% since the beginning of this year. Over the past three months, the stock has plunged 8.06% while the share price has tumbled 40.94% over the past 12 months.