Surge Components (SPRS) is one of the cheapest stocks I’ve seen on the market. The numbers speak for themselves: the company earned $1.5m in operating income last year, $1m in the first nine months this year, has $3.2m in cash (no debt) and over $7m in net working capital…. all of this against a market cap of (assuming all preferred shares are converted and current stock price of $0.44 per share) $4.3m.
Doing some quick math, the means SPRS is a consistently profitable company trading for less than 1x EV / EBIT and just over 60% of NCAV. As an added kicker, the company has a ton of deferred tax assets / net operating losses that, at today’s level of earnings, should shield it from paying more than a token amount of taxes for the next 4 – 5 years.
So back up the truck, mortgage the house, max out your credit cards, and buy every share you can get, right?
I’m not so sure. There are some serious, serious red flags here that have kept me from building a major position (much more serious than the red flags I discussed in fellow net-net AIRT). While I have bought some shares and would buy a few more on weakness, the red flags are just too much for me to make SPRS a serious position.
Let’s start with a brief history. Surge is a supplier of a variety of electronic components to a number of different industries. In effect, they’re basically a sales agent / distributor for Asian manufacturers. Surge went public in 1984 and is based in New York.
Any history of them would be incomplete without mentioning their first and biggest red flag. The company was listed on the Nasdaq until November 2001. The reason they delisted was because they were involved in a “questionable payment” scandal involving a payment of $3m to the wife of an employee of a supplier. The company received legal advice stating the payment was ok, but eventually their lawyer said they probably shouldn’t have made the payment. Surge asked for the $3m back and (shockingly) received $1m of it back (I say shockingly because I can’t believe someone involved in a “questionable payment” would give a dime of it back!).
To me, that’s just a huge red flag. Please feel free to review all of the disclosures yourself (it’s right at the front of their 10-k!), but it most have been some contract for a company that did $10m per year in revenue (as they did in the early 2000s) and was losing >$1m per year to pay $3m to win.
PS – if you’re thinking management was crooked then but has been replaced with straight shooters (note that I am not saying they are. I just think there are some major red flags), the CEO from back then is still CEO.
In the wake of this bribe scandal, NASDAQ delisted Surge. Surge, however, was still required to file with the SEC. For 5 years (Fiscal year 2004-2008), Surge did not do so. They say it was because the filing requirements were to onerous / expensive, which I completely understand. Still, that is another concern to add to our growing list.
Finally, when the company was ready to refile, they soon reincorporated, shifting from New York to Nevada. The company says they did so
because Nevada is a nationally-recognized leader in adopting and implementing comprehensive and flexible corporation laws that are frequently revised and updated to accommodate changing legal and business needs
I’m no expert on best states to incorporate, so I’ll take them at their word (they also provided a chart comparing NY to Nevada in their 2010 10-K, see page 6). However, it seems strange that they wouldn’t do so in Delaware if they were going to go through the trouble of reincorporating, as I’ve frequently heard Delaware mentioned as the most incorporation friendly state.
Finally, there’s the final red flag of executive compensation. The CEO and Vice President each own about 10% of the company (10% of the CEO, 9% or so for the VP). As long time readers know, I love to see strong insider ownership in stocks I own.
However, the market value of that 10% ownership stake only equals one year of compensation for them. The CEO and VP both made $425k in salary plus bonus for fiscal 2011. This is for a company that did $23m in sales and $6.6m in gross profit. That means, combined, the CEO and VP took home over 4% of sales and almost 15% of gross profits in salary. While I understand that the CEO and VP are likely vital to the business and can likely pay themselves whatever they want, I still think the salary is pretty aggressive and would much prefer to see them take the track JCTCF takes, where they take very low salaries and rely on a large equity stake and increases in shareholder value to make them rich.
To wrap this all up, I know I’ve focused on a lot of negatives here. Maybe you’re scratching your head wondering why I would even bother to take a position in the company. The answer is really simple: SPRS is cheap.
As a matter of fact, it might be the cheapest stock in the U.S. that has SEC filings. It’s trading for just 60% of NCAV and has a history of consistent earnings since it started reporting again. Consider this: it has earned almost $1m in the first nine months of this year. They earned $1.5m in fiscal 2011, $1.7m in 2010, and $440k in 2009 (the low earnings are likely entirely caused by the financial crisis). Even if you use 2009 as a baseline (which, again, was crisis level earnings), the company is trading for under 3x EV / EBIT and wouldn’t need to pay taxes for more than 10 years!
As an added kicker, Paul Sonkin of Hummingbird fame filed a 13-D and held 5%+ of the company in late 2010, though I can’t tell if he still owns those shares or not. I have seen him push for board seats and big dividends in companies he has a big stake in before, and given all of the excess cash at SPRS that could be the end game here.
Disclosure: Long JCTCF, SPRS, AIRT
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