[Premium]: An Asset Rich Microcap With Attractive Net-Net Valuation
Let’s say you have an opportunity to buy $20 worth of Current Assets (assets that are either cash or can be converted to cash quickly) – ALL liabilities, with only $15. That is 25% off. What if I told you that the book value of the business is $37 (that is if you also count the long term asset value such as plant and property and equipment)? This is a 60% discount to the book.
To make the decision easier, also consider the fact that the company has been more or less profitable through the downturn and has been generating positive cash flow and more recently the company reports that the business has been looking up. This is also a company that has been in the business for 40 years now. And just recently, the company fought off an unsolicited bid for acquisition from a rival.
Did I get your interest?
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The company in question is TII Network Technologies (TIII). As the subscribers to AIL Premium already know, I purchased shares in TIII recently.
According to its 10K, the company designs, manufactures and sells products to the service providers in the communications industry for use in their networks. Our products are typically found outdoors in the service provider’s distribution network, at the interface where the service provider’s network connects to the user’s network, and inside the user’s home or apartment, and are critical to the successful delivery of voice and broadband communication services.
Here is my rationale for the purchase.
The company is currently valued at $15.4 million by the market (as of Oct 2, 2009).
Lets look at its balance sheet for Q2, 2009 (numbers in 000s).
| Assets | Liabilities |
| Current Assets
Cash & Cash Equivalents 10,780 Accounts Receivables 3,017 Inventories 7,695 Deferred Tax Assets 611 Other Current Assets 432 Total Current Assets 22,535 Property, Plant & Equipment 8,308 Deferred Tax Assets 8,617 Other Assets 184 Total Assets 39,644 |
Current Liabilities
Accounts Payable 1,676 Accrued Liabilities 618 Short Term Debt 171 Total Liabilities 2,465 |
| Shareholder Equity | |
|
Common Stock 140 (par value .01, ~14m issued & outstanding) Additional Paid in Capital 42,645 Accumulated Deficit (5,325) Treasury Shares (at cost) (281) Total Stockholder’s equity 37,179 |
It is quite clear with a quick glance that the balance sheet is unusually rich in assets with very little debt. Additionally, most of the assets are current. The liquidation value of this company is going to be much much higher than $15.4 million that the market is currently pricing it. Not that the company is anywhere close to liquidation. Not at all. This makes the undervaluation even more striking.
To be conservative, you would discount some of the assets down (assuming a quick fire sale). Cash is cash and there is no reason to discount it. We will apply 15% discount to the AR assuming 15% in bad accounts. To be sure, the company’s bad account number is very nominal and 15% is being very conservative. The company also serves the market where the demand for its products will continue to exist with some obsolescence. You might therefore discount the inventory down by a greater amount, lets use 25%. Deferred tax assets have value but may take time to collect so you may choose to apply a 30% time value discount (which is also being conservative). PPE has lot of value, the company owns its own plant and property including land. Given that the company is a 40 year old company, the land values must be quite higher compared to what is being carried on the books. With that being said, taking a 30% discount to PPE number is very conservative. Finally, we will just ignore the other asset lines.
With these adjustments, the total adjusted assets for the company comes to:
10,780 + 3,017*.85 + 7,695*.75 + (611 + 8,617)*.7 + 8,308*.7 = 31,391
Subtracting the total Liabilities gives an Adjusted Book Value (or Intrinsic Value) of 31,391 – 2,465 = 28,926
Since the market is offering the company for sale at $15.4 million, we are able to buy the company at 47% discount to our conservative estimate of its book value.
This is quite a bargain.
Incidentally, this calculation also places the company intrinsic value at 28.9/14 = $2.07 per share
This valuation does not take the earnings power of the company into account. As the company continues to make money, its balance sheet will continue to improve and the intrinsic value will continue to rise.
If you demand atleast 30% return on investment in the company stock, you should be willing to buy the company shares upto 2.07*.7 = $1.45 per share today.
Now, I can also do an earnings power analysis and it will give me an intrinsic value that is higher than what we achieved here (Asset value + value of future earnings which are positive). Since the current analysis is sufficient to justify a purchase of the company stock, I will defer it until the time when the market price of the stock starts approaching the intrinsic value calculated here (to figure out if we should sell or hold).
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