The entire bullish case for JCTCF hinges on the growth of the company’s non-wood products division which is part of the company’s Lumber, Building Materials & Other (JCLC) group. I believe the non-wood products business is a hidden asset and will allow the company to grow the bottom line despite the slowdown in demand for commodity wood products.
There has been several headlines in 2007 that provide a glimpse that things are happening with non-wood products. For example, in January the company announced that it will sell its high-end dog kennels in 900 Petsmart stores. A few weeks later the company announced that they acquired patents and manufacturing rights to a vinyl gate system -- another non-wood product. In February, the company announced that Fred Myer will sell the high end dog kennels in 117 stores.
Here is another positive announcement related to non-wood products in March:
JCTCF “announced that the Company has received initial orders from two large national home centers for the Company's proprietary gate system for wood fences”
That’s a lot of positive headlines that have gone basically unnoticed as the stock is essentially flat year to date. Keep in mind that at the end of 2006 the P/E ratio was at only 12x-13x for a company with ROE north of 15% and almost zero leverage.
Headlines are one thing, but what do the numbers look like?
Here is where things get interesting. EPS for the last nine months (the fiscal ends in August) is $0.57 vs. normalized eps of $0.57 for the same period in fy2007 (the normalization removes a 16c gain in last years figures due to sale of a distribution facility).
So, what’s so great about investing in a company with zero earnings growth? Consider the fact that earnings are still flat while
1) this company sells wood products and the cost of lumber has plummeted. I don’t have exact statistics and JCTCF did not give any numbers in their latest filling but if you were to look at the latest filling from UFPI which I am a shareholder and have mentioned before you would see that lumber prices have fallen by at least 15% year-to-date.
2) its most profitable business segment last year (Greenwood) has experienced a 17% YoY sales decline and profits for that segment are down almost 50%
3) the company made no money in the “industrial tools” business which accounted for 4c of earnings last year at that time
When you consider that all these notable items have been completely offset by the more than doubling of profits in the JCLC segment and that all that increase was driven by non-wood products a different pictures start to emerge.
For the first nine months of the year, sales in JCLC are up only 2% while operating income for the unit is up 140% …..here is the single most important line from the 10Q
“this reflects a sizable increase in specialty metal products that slightly more than offset a sizable decrease in wood products sales. Operating income was up $889,886 [+140% YoY] reflecting the fact that the gross margin on specialty metal products is much higher than on wood products sales.”
I guess I am not sure what else I can say to get my point across.
When you buy shares of JCTCF you are getting a fast growing business segment with a huge potential market that is currently stuck in a middle of a pile of garbage. My bet is that either that garbage will be swept away over the next few years (lumber prices return back to normal levels) revealing the great business segment within. Or the business will continue to grow so much that it will be noticed while still surrounded by garbage.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Aug 3, 2007
Jul 13, 2007
JCTCF -- “Da Bears”
I generally try to summarize the bearish case with one sentences, in the case of JCTCF it can be summarized with one work – INCONSISTENCY.
For example, in the last fiscal quarter of 2006 (ending on August 2006) the company reported positive sales growth while YoY eps doubled. Furthermore, for the full fiscal year 2006 operating eps (which is actually lower than reported eps due to a one time gain) was up 115% on YoY basis. Based on the report the company looked like it was well on the way to driving margin improvement in its two biggest businesses and the turnaround was well under way.
However, the following quarter (fiscal 2007:Q1 and calendar November 2006) the company “crapped all over itself” to use a favorite moniker that our trading desk assigns to stocks that drop from $13 to $10 in one day. Revenue fell 15% YoY, operating net income which excludes the positive effect of $150K inventory write-down reversal fell by 56%.
Even worse, JCLC which holds the hidden asset of “non-wood” products and is in my mind the only reason to own this stock actually experienced a 26% decline in operating income and margins in that business unit actually fell. This kind of inconsistency really makes investors question why they should own a tiny, highly illiquid, microcap with management that rarely publicly talks to investors and provides no business updates. The revenue decline is bad enough, but that can be excused by the fact that most of the business is still based on commodity pricing but the decline in margins in JCLC was inexcusable.
In the following quarter, (fiscal 2007:Q2 and calendar February 2007) the company reported another strong quarter -- by my calculations the company registered 38% YoY operating income growth. However, the quarter was “mixed” as revenue fell again by double digit rates and cash flow was negative compared to positive the previous year at this point as inventory drastically increased.
The point is that while there certainly appears to be a turnaround going on at JCTCF and the company is heading in the right direction, the result have been inconsistent.
Also, it can be added to the bearish case that JCTCF still makes most of its revenue and income from commodity products. The revenue decline that has precipitated over the last few quarters—0%, -14%, -15% in the last three most recent quarters—is a perfect example of the danger that faces companies that sell a commodity product, of course JCTCF has been trying to change that.
While I am not spending much time on this – as it should be evident – an investment in JCTCF comes will all the dangers associated with highly illiquid, highly volatile, tiny winy microcaps.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
For example, in the last fiscal quarter of 2006 (ending on August 2006) the company reported positive sales growth while YoY eps doubled. Furthermore, for the full fiscal year 2006 operating eps (which is actually lower than reported eps due to a one time gain) was up 115% on YoY basis. Based on the report the company looked like it was well on the way to driving margin improvement in its two biggest businesses and the turnaround was well under way.
However, the following quarter (fiscal 2007:Q1 and calendar November 2006) the company “crapped all over itself” to use a favorite moniker that our trading desk assigns to stocks that drop from $13 to $10 in one day. Revenue fell 15% YoY, operating net income which excludes the positive effect of $150K inventory write-down reversal fell by 56%.
Even worse, JCLC which holds the hidden asset of “non-wood” products and is in my mind the only reason to own this stock actually experienced a 26% decline in operating income and margins in that business unit actually fell. This kind of inconsistency really makes investors question why they should own a tiny, highly illiquid, microcap with management that rarely publicly talks to investors and provides no business updates. The revenue decline is bad enough, but that can be excused by the fact that most of the business is still based on commodity pricing but the decline in margins in JCLC was inexcusable.
In the following quarter, (fiscal 2007:Q2 and calendar February 2007) the company reported another strong quarter -- by my calculations the company registered 38% YoY operating income growth. However, the quarter was “mixed” as revenue fell again by double digit rates and cash flow was negative compared to positive the previous year at this point as inventory drastically increased.
The point is that while there certainly appears to be a turnaround going on at JCTCF and the company is heading in the right direction, the result have been inconsistent.
Also, it can be added to the bearish case that JCTCF still makes most of its revenue and income from commodity products. The revenue decline that has precipitated over the last few quarters—0%, -14%, -15% in the last three most recent quarters—is a perfect example of the danger that faces companies that sell a commodity product, of course JCTCF has been trying to change that.
While I am not spending much time on this – as it should be evident – an investment in JCTCF comes will all the dangers associated with highly illiquid, highly volatile, tiny winy microcaps.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Jul 11, 2007
JCTCF -- Today's Earnings
Those of you that have not looked at JCTCF since I posted on the stock a few days ago should take a quick look at todays earnings announcement -- actually you are better off looking at the filed 10Q.
Based on simple YoY eps growth the company reported a very good quarter with "clean" EPS growth of 30%+. However, if you really dig into the 10Q and you know what to look for I think this was a blow out quarter.
If you remember, in my original post I classified JCTCF as a "hidden asset" type of investment. I also stated that the "Lumber, Building Materials & Other" (JCLC) segment which is made up of “wood” and “non-wood” products is really the key to this investment. The hidden asset being the "non-wood" products.
Here is the most important part of today's announcement:
" Sales at JCLC were $8,216,632 for the three months ended May 31, 2007, which was an increase of $1,514,124 or 18% compared to sales of $6,702,508 for the three months ended May 31, 2006. The increase primarily reflects a very significant increase in the sales of specialty metal products along with a moderate increase in wood products sales. Operating income was up $412,598 or 48% based on both the higher level of overall sales and particularly on the fact that the gross margin on the sale of the specialty metal products is much higher than on wood products sales."
While I am very happy to have some confirmation on my original thesis, one quarterly report does not change anything.
As I planned originally, my next post will concentrate on the bear case for the stock. I will than post the bullish case --again, the hidden asset within the company. I will also discuss the valuation and see how it has changed based on the new earnings and the price move over the next few days -- which looks like its going to be substantial.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Based on simple YoY eps growth the company reported a very good quarter with "clean" EPS growth of 30%+. However, if you really dig into the 10Q and you know what to look for I think this was a blow out quarter.
If you remember, in my original post I classified JCTCF as a "hidden asset" type of investment. I also stated that the "Lumber, Building Materials & Other" (JCLC) segment which is made up of “wood” and “non-wood” products is really the key to this investment. The hidden asset being the "non-wood" products.
Here is the most important part of today's announcement:
" Sales at JCLC were $8,216,632 for the three months ended May 31, 2007, which was an increase of $1,514,124 or 18% compared to sales of $6,702,508 for the three months ended May 31, 2006. The increase primarily reflects a very significant increase in the sales of specialty metal products along with a moderate increase in wood products sales. Operating income was up $412,598 or 48% based on both the higher level of overall sales and particularly on the fact that the gross margin on the sale of the specialty metal products is much higher than on wood products sales."
While I am very happy to have some confirmation on my original thesis, one quarterly report does not change anything.
As I planned originally, my next post will concentrate on the bear case for the stock. I will than post the bullish case --again, the hidden asset within the company. I will also discuss the valuation and see how it has changed based on the new earnings and the price move over the next few days -- which looks like its going to be substantial.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Jul 9, 2007
JCTCF -- First Look
Initially attracted to this stock for the following reasons:
-substantial EBITDA and earnings growth but still low multiple
-recently strong ROE without much leverage
-very thinly traded (roughly 5K shares per day) and very large insider ownership
-extreme stock volatility over last 18 months despite steady earnings growth
Share Price…….$8.17
Market Value …..$20M
Enterprise Value: ….$24M
Investment Type: …..Hidden Assets
Jewett Cameron Trading Co. Ltd (JCTCF) has four business lines with Greenwood and JCLC accounting for 90% of 2006 sales.
Business Lines
Industrial Wood Products (aka Greenwood) essentially sells treated lumber and other wood products to OEMs in the transportation and recreational boating industry. In the latest 10K the company tries to make the case that these are “value added” products with a lot of customization but based on margins and the recent financial performance of this business and management’s comments this is still largely a commodity business. Also, not only is this business a commodity business a large part of the unit sales (34%, 41%, and 39% in 2006, 2005, and 2004 respectively) came from the recreational boating industry which is highly leveraged to the economy.
Lumber, Building Materials & Other (JCLC) is made up of “wood” and “non-wood” products. The wood products are all pure commodity products with the final users being the residential remodeling or DIY market. The products are sold either at the company’s distribution center and home improvement retailers/center. The “non-wood” products are sold primarily by home improvement retailers and include dog kennels, greenhouses, gates, etc. The company has been expanding the number of “non-wood” products in its lineup and has increased the number of stores that sell these products. I will talk at length about this segment of the JCTCF’s business in further posts as I believe it’s the key to the investment thesis.
Seed Processing and Sales (JCSC) is in the business of taking raw seeds and processing them into marketable products to be sold to farmers.
Industrial Tools and Clamps (MSI) imports and distributes pneumatic air tools and industrial clamps. MSI owns the brand names while the manufacturing is done in Asia. In the lastest 10K, the company estimates that the pneumatic air market at $1B in annual sales with many competitors. The industrial clamps market is estimated at $400M in annual sales with fewer competitors and where JCTCF feels they can take market share.
As always, in the following posts I will outline the Bear and Bull cases for the stock and conclude by deciding if this stock will be added to the Best Ideas or Watch List portfolio.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
-substantial EBITDA and earnings growth but still low multiple
-recently strong ROE without much leverage
-very thinly traded (roughly 5K shares per day) and very large insider ownership
-extreme stock volatility over last 18 months despite steady earnings growth
Share Price…….$8.17
Market Value …..$20M
Enterprise Value: ….$24M
Investment Type: …..Hidden Assets
Jewett Cameron Trading Co. Ltd (JCTCF) has four business lines with Greenwood and JCLC accounting for 90% of 2006 sales.
Business Lines
Industrial Wood Products (aka Greenwood) essentially sells treated lumber and other wood products to OEMs in the transportation and recreational boating industry. In the latest 10K the company tries to make the case that these are “value added” products with a lot of customization but based on margins and the recent financial performance of this business and management’s comments this is still largely a commodity business. Also, not only is this business a commodity business a large part of the unit sales (34%, 41%, and 39% in 2006, 2005, and 2004 respectively) came from the recreational boating industry which is highly leveraged to the economy.
Lumber, Building Materials & Other (JCLC) is made up of “wood” and “non-wood” products. The wood products are all pure commodity products with the final users being the residential remodeling or DIY market. The products are sold either at the company’s distribution center and home improvement retailers/center. The “non-wood” products are sold primarily by home improvement retailers and include dog kennels, greenhouses, gates, etc. The company has been expanding the number of “non-wood” products in its lineup and has increased the number of stores that sell these products. I will talk at length about this segment of the JCTCF’s business in further posts as I believe it’s the key to the investment thesis.
Seed Processing and Sales (JCSC) is in the business of taking raw seeds and processing them into marketable products to be sold to farmers.
Industrial Tools and Clamps (MSI) imports and distributes pneumatic air tools and industrial clamps. MSI owns the brand names while the manufacturing is done in Asia. In the lastest 10K, the company estimates that the pneumatic air market at $1B in annual sales with many competitors. The industrial clamps market is estimated at $400M in annual sales with fewer competitors and where JCTCF feels they can take market share.
As always, in the following posts I will outline the Bear and Bull cases for the stock and conclude by deciding if this stock will be added to the Best Ideas or Watch List portfolio.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Jul 5, 2007
Marketocracy Portfolios -- June 2007
As mentioned earlier I will maintain 2 separate Marketocracy portfolios to provide some type of performance attribution to the readers of this blog. I will publish the holdings/weights of the “Best Ideas Portfolio” on a monthly basis and discuss any new buys/sells. I will not spend much time on the “Watch List Portfolio” as it will simply hold all the stocks analyzed on the blog but not included in the Best Ideas portfolio.
Best Ideas Portfolio
FTAR ($4.20) ….weight = 5% (full position with target weight of 8%)
BOOT ($18.01)…..weight = 2% (based on my post on 6/9/2007 my sell price is $21-$23, and the stock would need to fall to below $15 for me to increase it to a full position and buy more)
CPY ($69.5)……weight =1% (I posted that I feel this stock is worth at least $105 but that is likely to change as PCA’s financials are disclosed over the next few quarters. Applying a margin of safety, I posted that I would dip my toes in the water if the stock hit $65 and initiated a 1% position at that price. If the stock falls to below $55 I will buy another 1% other than that I am on hold until I see what’s under the hood of PCA)
INFS ($2.23)……weight = 1% (I recently posted that I feel that this maybe a case of a “turnaround that never turns” but I believe that below $2.50 the shares trade at a deep discount to acquisition value. I will add another 1% in the Best Ideas portfolio if the stock dips below $2 per share)
Cash 91%
*All stocks purchased in June 2006
Performance
Best Ideas Portfolio…-0.30%
Watch List Portfolio…-0.08%
Russell 2000 ….-1.46%
Core CPI + 10% ….at this point this is not a meaningful measure for comparison purposes
Keep in mind that the two Marketocracy portfolios hold 91% and 85% in cash, respectively.
As I stated initially, I will use cumulative returns since inception until I reach a 3 year track record. After that I will use a 3 year moving average as well as cumulative performance. I would not pay much attention to the returns versus these benchmarks until there is at least an 18 month rack record and there has been at least one 12 month period with the major indexes down 10% or more.
Again, I want to mention that I have long position in all stocks mentioned in this post and have a vested interested in promoting my long positions. The “Best Ideas Portfolio” is NOT A RECOMMENDED PORTFOLIO. The weight of each stock mentioned in the post is substantially different in my personal portfolio and it would be mistake to replicate this portfolio exactly in your investment account. These portfolio are relevant in the context of this blog only.
Best Ideas Portfolio
FTAR ($4.20) ….weight = 5% (full position with target weight of 8%)
BOOT ($18.01)…..weight = 2% (based on my post on 6/9/2007 my sell price is $21-$23, and the stock would need to fall to below $15 for me to increase it to a full position and buy more)
CPY ($69.5)……weight =1% (I posted that I feel this stock is worth at least $105 but that is likely to change as PCA’s financials are disclosed over the next few quarters. Applying a margin of safety, I posted that I would dip my toes in the water if the stock hit $65 and initiated a 1% position at that price. If the stock falls to below $55 I will buy another 1% other than that I am on hold until I see what’s under the hood of PCA)
INFS ($2.23)……weight = 1% (I recently posted that I feel that this maybe a case of a “turnaround that never turns” but I believe that below $2.50 the shares trade at a deep discount to acquisition value. I will add another 1% in the Best Ideas portfolio if the stock dips below $2 per share)
Cash 91%
*All stocks purchased in June 2006
Performance
Best Ideas Portfolio…-0.30%
Watch List Portfolio…-0.08%
Russell 2000 ….-1.46%
Core CPI + 10% ….at this point this is not a meaningful measure for comparison purposes
Keep in mind that the two Marketocracy portfolios hold 91% and 85% in cash, respectively.
As I stated initially, I will use cumulative returns since inception until I reach a 3 year track record. After that I will use a 3 year moving average as well as cumulative performance. I would not pay much attention to the returns versus these benchmarks until there is at least an 18 month rack record and there has been at least one 12 month period with the major indexes down 10% or more.
Again, I want to mention that I have long position in all stocks mentioned in this post and have a vested interested in promoting my long positions. The “Best Ideas Portfolio” is NOT A RECOMMENDED PORTFOLIO. The weight of each stock mentioned in the post is substantially different in my personal portfolio and it would be mistake to replicate this portfolio exactly in your investment account. These portfolio are relevant in the context of this blog only.
Jul 3, 2007
INFS -- “Final Thoughts”
In the previous 5 posts I talked at length about the problems faced by INFS as well as the attractive aspects of an investment in the company.
INFS continues to see prices for its products drop by double digit rates due to roughly 30-40 competing projector manufacturers as well as the ascent of LCD/Plasma televisions.
However, INFS is now controlled by a hedge fund which is the firm’s largest shareholder and will be picking the new management team and setting the new policies, the company has a fortress balance sheet, and it appears that the stock is trading at a discount to the combination of tangible liquidation value + non-tangible assets that certainly posses value for an acquirer.
If there is value for the shareholder, why didn’t anyone purchase INFS when it effectively put itself up for sale a few months ago?
I don’t have a definitive answer to this question but my feeling is that it would be hard for any CEO to justify buying a money losing operation even if he/she feels there is value to be added. Also, since Caxton is actively involved it’s highly likely that they would be looking for a very high premium – again, something most CEO’s could not justify to their boards, shareholders, or analysts.
There will be more key data points coming from the company within the next 6 months. The biggest in my opinion will be hiring of the new CEO and CFO by Caxton and the plan that will be outlined to other shareholders to turn the company around. There will also be a new proxy filled and it will be key to see how the two top people at the firm will be incentivised. Will their biggest gains come only if shareholders benefit (mostly long term restricted stock based compensation plan) or will they be awarded with mostly cash salaries and large parachutes?
Another two key data points in the next few quarters will be the trend in Gross Margins and G&A expense. Obviously these are key metrics for any company any time, but in the case of INFS the trends in Gross Margins and G&A expense will make the difference between survival and bankruptcy.
On the last quarterly call the recently departed CFO stated that gross margins took a 360bps SEQUENTIAL hit due to the company clearing out inventory of IN72 projectors and selling a lot more of the lower price point IN24 and IN26 projectors causing sequential volumes to go up 15% while revenue was down 7%. The CFO stated that they “aggressively sold these products” which of course in the real world means: “CRAZY EDDIE HERE, AND EVERYTHING MUST GO. SALE, SALE, SALE!!!!!!!” While aggressive discounting of course kills margins, the positive is that it clears the deck of old products and turns inventory into cash which the company needs right now. While not as clearly, that much was stated by management on the last call.
The company also needs to cut G&A expense immediately. While there is always a degree of uncertainty around new product introductions which management has no control over, expenses are completely under management’s control. The company needs to cut expenses and needs to do it immediately – this is where a new CEO/CFO team can make an immediate impact. Again, on the last conference call guidance was for $14.5M - $15.5M in quarterly G&A as the goal by year end from the current level of $19.2M in Q1:2007. It will be up to new management to cut expenses without cutting R&D. Cutting costs is great, but where to cut with manufacturing and call centers already outsourced?
One place where I think some cuts can be made is in the development/support of the dealer network as well as some general “home office” jobs. As I understand the business model, the company spends a lot of time training and supporting dealers that sell their product. This is a key function of course, but there maybe room to trim the least profitable dealers (which will mean giving up sales) and the people employed to support them (more profits from fewer dealers). This is by no means a given and in my experience the odds are against any new management team faced with this task.
So is INFS going to be added to the Watch List or the Best Ideas portfolio?
Based on my previous post, I think INFS is trading at a substantial discount to what an acquirer would be willing to pay for the company. The company is now run by the largest shareholders and it the company has the balance sheet needed for such a massive turnaround. Therefore I have added a 1% position in INFS to the Best Ideas portfolio. You will recall that my target for this portfolio is to have 10 full positions at roughly 8% each and 10 smaller positions that will hopefully be increased to full positions eventually.
What will I be watching for in the next few quarters?
I will be looking for a sequential bounce in Gross Margins as the company has apparently moved out the old discounted inventory and should see an increase as it starts selling more higher priced products. I don’t think the company is close to hitting the long term targeted GM of 16% to 18%, but not seeing an immediate increase would be a very bad sign.
After new management is hired I will be looking for declining G&A – are they heading towards previously guided $14.5M to $15.5M? What is management doing to cut expenses immediately?
Details of new CEO’s and CFO’s long term compensation – is it long term stock based or mostly cash?
I will also be looking for trends in revenue and average prices in Q3 and especially Q4. The projector industry is seasonal with most of the sales done in Q3 and Q4, with Q4 being by far the most important. Right now the stated plan is to migrate customers to higher margin IN24+ and IN26+ as well as new product launches like the IN10 ultra mobile projector. If after clearing out inventory the company can’t increase Gross Margins and show at least some initial increase in sales, there is no reason to own this stock.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
INFS continues to see prices for its products drop by double digit rates due to roughly 30-40 competing projector manufacturers as well as the ascent of LCD/Plasma televisions.
However, INFS is now controlled by a hedge fund which is the firm’s largest shareholder and will be picking the new management team and setting the new policies, the company has a fortress balance sheet, and it appears that the stock is trading at a discount to the combination of tangible liquidation value + non-tangible assets that certainly posses value for an acquirer.
If there is value for the shareholder, why didn’t anyone purchase INFS when it effectively put itself up for sale a few months ago?
I don’t have a definitive answer to this question but my feeling is that it would be hard for any CEO to justify buying a money losing operation even if he/she feels there is value to be added. Also, since Caxton is actively involved it’s highly likely that they would be looking for a very high premium – again, something most CEO’s could not justify to their boards, shareholders, or analysts.
There will be more key data points coming from the company within the next 6 months. The biggest in my opinion will be hiring of the new CEO and CFO by Caxton and the plan that will be outlined to other shareholders to turn the company around. There will also be a new proxy filled and it will be key to see how the two top people at the firm will be incentivised. Will their biggest gains come only if shareholders benefit (mostly long term restricted stock based compensation plan) or will they be awarded with mostly cash salaries and large parachutes?
Another two key data points in the next few quarters will be the trend in Gross Margins and G&A expense. Obviously these are key metrics for any company any time, but in the case of INFS the trends in Gross Margins and G&A expense will make the difference between survival and bankruptcy.
On the last quarterly call the recently departed CFO stated that gross margins took a 360bps SEQUENTIAL hit due to the company clearing out inventory of IN72 projectors and selling a lot more of the lower price point IN24 and IN26 projectors causing sequential volumes to go up 15% while revenue was down 7%. The CFO stated that they “aggressively sold these products” which of course in the real world means: “CRAZY EDDIE HERE, AND EVERYTHING MUST GO. SALE, SALE, SALE!!!!!!!” While aggressive discounting of course kills margins, the positive is that it clears the deck of old products and turns inventory into cash which the company needs right now. While not as clearly, that much was stated by management on the last call.
The company also needs to cut G&A expense immediately. While there is always a degree of uncertainty around new product introductions which management has no control over, expenses are completely under management’s control. The company needs to cut expenses and needs to do it immediately – this is where a new CEO/CFO team can make an immediate impact. Again, on the last conference call guidance was for $14.5M - $15.5M in quarterly G&A as the goal by year end from the current level of $19.2M in Q1:2007. It will be up to new management to cut expenses without cutting R&D. Cutting costs is great, but where to cut with manufacturing and call centers already outsourced?
One place where I think some cuts can be made is in the development/support of the dealer network as well as some general “home office” jobs. As I understand the business model, the company spends a lot of time training and supporting dealers that sell their product. This is a key function of course, but there maybe room to trim the least profitable dealers (which will mean giving up sales) and the people employed to support them (more profits from fewer dealers). This is by no means a given and in my experience the odds are against any new management team faced with this task.
So is INFS going to be added to the Watch List or the Best Ideas portfolio?
Based on my previous post, I think INFS is trading at a substantial discount to what an acquirer would be willing to pay for the company. The company is now run by the largest shareholders and it the company has the balance sheet needed for such a massive turnaround. Therefore I have added a 1% position in INFS to the Best Ideas portfolio. You will recall that my target for this portfolio is to have 10 full positions at roughly 8% each and 10 smaller positions that will hopefully be increased to full positions eventually.
What will I be watching for in the next few quarters?
I will be looking for a sequential bounce in Gross Margins as the company has apparently moved out the old discounted inventory and should see an increase as it starts selling more higher priced products. I don’t think the company is close to hitting the long term targeted GM of 16% to 18%, but not seeing an immediate increase would be a very bad sign.
After new management is hired I will be looking for declining G&A – are they heading towards previously guided $14.5M to $15.5M? What is management doing to cut expenses immediately?
Details of new CEO’s and CFO’s long term compensation – is it long term stock based or mostly cash?
I will also be looking for trends in revenue and average prices in Q3 and especially Q4. The projector industry is seasonal with most of the sales done in Q3 and Q4, with Q4 being by far the most important. Right now the stated plan is to migrate customers to higher margin IN24+ and IN26+ as well as new product launches like the IN10 ultra mobile projector. If after clearing out inventory the company can’t increase Gross Margins and show at least some initial increase in sales, there is no reason to own this stock.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
Jun 27, 2007
INFS -- “Da Bulls” Part III
The first two bullish posts talked about shareholders controlling the firms destiny and INFS having the balance sheet required for a turnaround. This post will concentrate on valuation.
Since we are in the early innings of the “turnaround” and its impossible (at least for me) to estimate future cash flow, the only relevant way to value this company is by trying to calculate an acquisition value.
Lets see what this pig is worth ……fist lets look at the tangible liquidation value
Cash & Equivalents ……. $78M
Net Receivables …… $35M (reported $47M, discount by 25%)
Inventory …… $18M (reported $36M, discounted by 50%)
Other CA $9M
Current Liabilities……. ($83M)
Other LT Liab ……. ($4M)
Tangible Liquidation Value …$53M or $1.33M per share
Value of Motif* ……. $23M (50% share of 15x 2006 net income of $3.1)
Non-Cancelable Leases….. ($17M)
Revenue from Sub-Leasing** …$8.5M
Intangible Liquidation Value …..$10.2M (total intangible value $14.5M discounted by 30%)
Total Liquidation Value $63.2M or $1.60/sh
Current Market Value $97M or $2.44/sh
*Motif is a 50/50 JV with Motorola. Net income in 2006, 2005, 2004 has been $3.1M, $7.3M, $4.7M respectively (note 12 in 2006 10K).
**INFS currently sub-leases some the properties it liquidated as part of the restructuring. To be conservative, I assumed they could sub-lease their current properties at 50% of what they are paying.
What is not included in this liquidation value but is worth something to an acquirer?
1) by far the biggest thing that is missing from $1.60 liquidation value I calculated above is the over $200M in NOL’s that INFS is currently carrying. The problem is that you can’t just discount the $200M and add it to value of the company because the nature of tax laws give different acquires different abilities to use the NOL’s. On the last conference call, the CFO (who is no longer with the company) said that much. However, he also said that to the right buyer the NOL’s have real dollar value.
How much could they be worth? Well, lest say the acquirer can only use 50% of the NOL’s over the next 10 years. Discounted at 6%, the PV is $56M or $1.41/share.
2) another exclusion from the above liquidation value is INFS “intellectual property” (patents, R&D department, brand name, etc.) and its reseller network. While its hard for me to assign a specific dollar value to the company’s intellectual property I think it has a value of more than zero. Despite its problems, INFS still has patents and the know how to make high quality projectors and I feel that this technology is worth something to a potential acquirer. They also have years of relationships with resellers and do posses shelf space that has a tangible dollar value to an acquirer.
I am not going to spend a lot of time talking about the “brand name” even though they state (very often) that they have the largest installed base of projectors and leading brand name. I think its pointless to talk about your “brand name” when you have seen ASP’s fall by double digit rates over the last 4 years– obviously your brand name is not very strong.
So what does this all mean?
Well, I think at the current market price of $2.44 per INFS share you are getting $1.60 of tangible liquidation value as wells as $200M+ of NOLs and the company’s intellectual property which I think is worth over $1.50 per share – even if the acquirer can only use half of the NOL’s they are worth $1.40/share by my calculations.
Obviously INFS is a very high risk investment in the early stages of a shareholder led transformation, but at current prices you are paying a discount to acquisition value.
The next post will conclude my analysis of INFS.
* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.
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