Last week I did a post on ADDvantage (AEY) with some questions I thought would be interesting on the earnings call. A reader was kind enough to ask them, so I wanted to do an update post earnings call (and with the 10-K filed).
The first was a question about their decline in inventory reserves and if they had used the decline to play an earnings game. I posted this question before the 10-K was filed, and management answered that the decline was the result of a write off. So the good news here: no earnings game to hit street targets.
The bad news: I think management may be under-reserving for obsolete inventory now.
Take a look at this chart buried in the back of their 10-K.
Sales were over $32m in 2010 and under $21m in 2011. Despite this (and the fact some of those sales are coming from their Adams acquisition), the company has significantly run down their reserve for obsolete inventory.
Now, I don’t want to overstress this fact because 1) even if they had kept inventory reserves steady, it would barely effect book value / NAV (plenty of margin of safety here) and 2) inventory has also fallen (though not by as much as reserves). Plus, it could be argued that AEY had significantly over reserved for a long time.
But it is just something to keep an eye on.
My second question was about share buybacks. And I think the reader posed the question really well. He (and I paraphrase a bit) started by saying he knew mgmt preffered acquisitions to buybacks right now, but if there was ever a point if they’d consider the buybacks over acquisition (he specifically asked if the share price were $1 instead of $2 if they would consider it).
The CFO answered and said they’d look at it, but they still felt better w/ acquisitions over buybacks at today’s prices.. The CEO added that they could barely get any shares given the volume the stock trades at without going Dutch tender and added a bit more that basically said “no buybacks, we’re buying something.”
I can’t overestimate how wrongheaded I think that is of management. These guys have a profitable business with plenty of excess cash trading for less than half of book value. There is absolutely no better way to create value than through doing a Dutch tender. Here’s what I’d do if I were them
- Announce a Dutch tender and price it at 10% above today’s price
- Buyback every single share that’s tendered
Here’s my logic behind that- management owns almost 50% of the company, so they have excess cash equal to almost half of the free floating shares.
And they’ve got plenty of borrowing capacity- not only do they have all that excess cash, but AEY has inventory that they can borrow against and several unlevered properties that they could use to borrow.
So they could easily buy back every single share that’s tendered. And that would create huge value for remaining shareholders, given the buyback would be done at under NCAV and less than 60% of book.
And if they wanted to do acquisitions after that? Well, that wouldn’t be a problem. AEY’s still generating profits, and (again) they’ve got plenty of borrowing power. If they found an acquisition they really liked, I guarantee you they could get plenty of financing for it between the business they were about to buy’s inventory (used to secure a bank loan), their inventory and properties (mentioned above), and even having the seller take a small note back if they desperately needed to.
In other words: there’s absolutely no reason they can’t buy back shares and pursue acquisitions. Failing to do so is, quite frankly, really harming shareholders at these levels.
Disclosure: Angry, but still long AEY in a very big way.
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