Lately, I’ve been talking about stocks that are, by the standards of this blog, relatively huge. Both RAS and ATPG (analyzed both ATPG bonds and ATPG equity) have market caps of ~$250M+ and balance sheets in the billions. Considering I normally focus on stocks with market caps under $50m and balance sheets under $100m, those companies are giants!!! Plus, their balance sheets are super complex, with non-recourse assets, multiple publicly traded securities, complex financing, etc. So today, we go back to the heart and soul of this blog and look at a simple microcap with a <$15m market cap and ~$20m balance sheet: Micro-pac (MPAD).
The great thing about getting “back to the basics” and writing up a company like MPAD is that the write up is relatively simple and straightforward, so expect a quick and simple post!
PS- Micro-pac was suggested to me by a reader (feel free to give me your suggestions! The smaller and more obscure the better! I promise I will try to look into them all!), so thanks for the suggestion!!!
The company designs, manufactures, and distributes hybrid microelectric circuits, solid state relays, and a variety of other products that I have no idea what they are or what they do.
Normally, that would make the company a quick pass for me. But that quick pass is because not understanding what a company’s products are normally means cutting edge high-tech products. That’s not the case with Micro-Pac. Micro-Pac’s products enjoy long life-cycles (meaning low risk of sudden technological obsolescence), and are small but critical components of a broad range of aircraft and navigational instruments.
Their products are also relatively commodity based. The company notes that their are at least two competitors selling all of their products, and the business enjoys margins in the high single digits to low double digits, which are normally indicative of a lack of competitive advantage.
However, the lack of competitive advantages doesn’t mean MPAD can’t earn decent ROIC. After adjusting for excess cash, ROIC over the past year comes in over 30% because the company does a great job of keeping invested capital low. And this isn’t a one time fluke- ROIC over the past five years has consistently come in at 20-25%+, and the company has enjoyed operating profits in each of the past ten years.
So that’s enough for the quick overview of Micro-Pac. Again, the business is small and relatively simple. You’re welcome to dig into further if you’re interested in the stock (in fact, I encourage you to), but the broad overview is enough for our purposes.
So let’s move on to valuation. MPAD has averaged ~$2.5m worth in EBIT over the past five years. Given the company is doing so at very nice ROIC, that $2.5m is likely worth ~10x EBIT, which would imply an EV of $25m.
With the market cap standing today at ~$14m, that would imply a significant jump in market cap from here. However, this simple analysis actually understates MPAD’s value. Like many of the company’s discussed on this site, MPAD sits on a significant net cash position (GTSI is another great example). After backing out a special dividend they just paid out, MPAD has just under $10m in cash with no debt outstanding. That equates to almost $4 per share versus today’s stock price of $5.25!
So if we add up the $10m in net cash plus the $25m in operating value, we’d come out with a target market cap of $35m, or $13-14 per share versus a current price of $5.25.
That seems about right to me. But you’ll notice in my disclosure at the end of this post that I haven’t bought yet, despite significant upside and great downside protection.
Why?
First, I need to free up some cash. I’m going to have an article coming out soon discussing how difficult I’ve found it to sell cheap and buy cheaper. I’m sure many of you have experienced the same thing.
However, there are also some company specific concerns. Sales are highly dependent on government funding for space and military products, and both of those appear on the way down as the U.S. deals with its huge debt load. Indeed, revenue and backlog are both down pretty significantly year over year.
Finally, the company is majority owned (>75%) by an 82 year old German investor. In other words, the chances of any activism taking place here are nil. Share ownership by management outside of the German investor is basically non-existent. Such large ownership by one shareholder combined with small mgmt ownership has to be concerning for any investor as it raises plenty of questions. A few quick samples- What happens when the shareholder dies? Does the company get bought out or does management run wild, using the excess cash for huge bonuses and crazy acquisitions? Etc.
But those concerns seem more than made up for by today’s low prices. Assuming MPAD stays around today’s prices, I’ll likely add some over the next week. Normally, I don’t post until I actual own the stock, but since I’m going to need to sell something to add MPAD, it wouldn’t kill me if you beat me to it.
Disclosure- Long GTSI, RAS, ATPG bonds. Likely to add MPAD in the near future.
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I’ve been monitoring MPAD for some time. It’s very similar to SODI in many ways.
If I’m not mistaken, the German investor is (or, was) the COO’s of MPAD’s German branch. Last year, he moved the shares to a family trust. Looks like it’s part of his estate planning. That can be a catalyst.
But the bank covenant of its line of credit requires it to maintain $10m NTA. So, unless that’s revised, it’s unlikely we will get dividends.
Me being cheap is sitting on the sideline, waiting for 2/3 NCAV.
Thanks for the comment. I think it’d be an absolute STEAL at 2/3 of NCAV. I hope it gets there too! I do have a buy order at very close to today’s prices in now.
Whopper,
I wrote them up about a year back or so, I was finally able to establish a position in the 4s a few months back.
I’d look at the insider purchases again, the CEO has been making some open market purchases recently. The German investor is closely tied to the company, his German company is fascinating as well. It was selling pretty cheaply when I looked at it if I remember correctly.
As J Mako stayed MPAD is very similar to SODI which is well below NCAV again. I hold both of these companies. The military risk exists but I’ve noticed most people mention it as a bit of a red herring. If you go digging into the planned military cuts you can find exactly what will be cut and what won’t, it’s all online.
A long as satellites need to be launched I think MPAD will do alright. I am content to wait for a few years in this one.
Nate
Hey Nate,
Just saw your old write up. I’ll be sure to link to it in the near future. I agree with you that MPAD should do well, I was just pointing out concerns. I cleared some cash up and have some buy orders out, so hopefully I get filled in the near future!
I have a pretty nice position in MPAD around $5.50. Business has had very nice ROIC over the last 10 years, share count has remained stable, and cash has built up considerably. I always worry about what good companies with low reinvestment opportunities will do with their cash, but I think the large shareholder mitigates some of that risk. I’d re-look at the comment on the credit facility — I could be wrong, but it seems like they could return ~ $8mm in cash (or 60% of the market cap) and still maintain net tangible assets of > $10mm (tangible book value of ~ $18mm right now w/ ~ $10mm of cash). I like the CEO buying stock recently. Military spending cuts (government spending cuts period for that matter) are certainly headed our way with the fiscal mess we are in as a country, but even if you assume revenues are cut in half, MPAD still breaks even. Not bad downside protection and quite a bit of upside potential if things don’t get really bad.
Hey PB,
I agree with you. I’ve added 3 net net positions recently (MPAD, OPST, and one to come out in a post thursday or friday), and I actually think MPAD is the most undervalued. Great downside protection, plenty of upside. And while I normally don’t care about divs, I do like them in net-nets as it shows mgmt is willing to return cash to shareholders.
Has anyone here talked to management? I wonder what Hempel’s intentions are. In theory (although a special committee of the board would probably get a fairness opinion to make sure it’s papered up — which I’m sure they could do), Hempel could (1) tender for the rest of the company (they are a Deleware company so I think he’d only need 90% of the shares — or an incremental 14.3% of shares) at a 100% premium ($11 per share), (2) pay for it with cash from the company ($6.9mm), (3) pay himself a post-closing dividend of $3.2mm, and (3) own a company that very quickly produces an additional ~ $500k earnings as a result of reduced registration-related expenses. What am I missing?
interesting point- but i wonder all the time why microcaps don’t go private. Don’t remember off the top of my head, but are they incurring that much in registration expenses? They are OTC, and my understanding is compliance costs are significantly lower for OTC companies. I can’t remember if they disclosed their compliance costs or not.
from the micro cap CEO/CFOs I’ve talked to it seems like the bare minimum in time/cost/etc to be public is ~$250-300k just for additional internal control staff, auditor fees, document preparation, CFO time, so $500k is not unreasonable but I’d probably eyeball it closer to $300k
First, awesome site, recommended by Geoff Gannon along with Oddball stocks, Value Uncovered, etc, all great sites I am now subscribing to. Am a newbie, have question on your valuation if you don’t mind.
ROIC at 25%, EBIT at 2.5 million avg over 5 years, how did that give you a EBIT multiple of 10? I understand how you used that multiple to get 25 million market cap but am unsure how you came to 10XEBIT.
Thanks in advance for any help you can give. Net-Nets seem to be a bit more straight forward than large cap companies.
PS.
What screening tool do you use? I came across Screener.co, any thoughts on that one or suggestions for another one? Thanks
Mike
Hi mike,
I generally use ebit multiples somewhere between 8-10x. These are very, very conservative multiples. Think of it like a bond- using a 10x ebit multiple is the same as asking for a 10% interest rate as a bond investment.
If you haven’t read it yet, the little book that beats the markets – http://www.amazon.com/Little-Still-Market-Books-Profits/dp/0470624159/ref=sr_1_1?ie=UTF8&qid=1330534486&sr=8-1 – has a great discussion on using EBIT.
Thanks, I appreciate it. Would you say it similar to using the conservative end of the historical Schiller Index?
I will check the book out. Thanks again and keep up the good work.
10x ebit seems pretty aggressive to me personally but I understand why you use it. depending on taxes that is probably approaching the high end of what a private acquirer would pay, slapping a 35% tax rate on that gets to a pretty aggressive p/e to me. I would probably aim more at like a 10-12 P/E for any business unless there is rapid growth and/or some crazy synergies