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Another “Simple” Net-Net: Solitron
Posted by: whopper investments (IP Logged)
Date: February 6, 2012 08:29AM

Recently, I’ve focused quite a bit on “simple” net-nets- MPAD on Monday, and OPST on Weds. Today, I’m going for the tri-fecta by writing about one more- Solitron (SODI).

SODI has been quite well covered on the “value” blog-o-sphere: I believe the first place it was written up was in this guest post at greenbackd; Gannon then wrote it up several times (here’s one, which includes discussions on George Risk and BDMS, two stocks I’ve previously invested in and written up), and then oddball stocks had a long and well researched series covering them. Finally, a reader pointed me to a relatively new blog with a post on SODI.

So obviously the company has been pretty well researched. I’ve followed it for a long time but never pulled the trigger on it.

Why?

Basically, I know nothing about what they do, so I’ve previously refused to invest in it at cheaper prices than today.

However, I’ve moved past that concern at this point. If a company has relatively stable operations (i.e. isn’t a complete cyclical with massive losses and huge profits depending on the economy) and has most of their assets in something I’m comfortable with (this is key- if SODI was made up of exclusively inventory of products I couldn’t understand, I would pass. They’re not.), I now feel comfortable adding it to my net-net basket even if I don’t have a great grasp on their business fundamentals.

As a quick summary, the business makes semi-conductors for the aerospace and military markets. Value investors have been attracted to the company’s large cash balance (for its size, of course) and consistent profitability.

It’s not hard to see why everyone’s been so attracted. Tangible BV comes in at $4.08 and consists almost exclusively of cash and other current assets, versus today’s price of ~$3.00 (note: I started writing this as today’s massive rally happened. Looks like SODI will close in the ~$3.20 range).

However, tangible book may underestimate the company’s worth. Trailing twelve month ebit comes in over $1.1m, and their average EBIT for the past five years comes in just over $825k. If we assume the company can earn $1m per year in ebit going forward, give that EBIT a simple 8x multiple, and then add back all of the net cash and investments, that company is worth $6.20 per share.

Simple?

Yes. But I think even that might undervalue the company for two reasons.

First, let’s start with their liabilities. They have just under $2m in liabilities (versus $12.2m in total assets). Of that $2m, just over $1m is from pre-petition bankruptcy claims.

What’s that?

Basically, in the early 90s, SODI went bankrupt. As they reorganized, they had some large liabilities left over, some related to their creditors, some related to environmental matters. Most (basically all, except for this one, as far as I can tell) of them have been settled at this point. This $1m accounts payable is payable quarterly at $7k per quarter until exhausted.

Think about that. It will take well more than 30 years to pay all of this A/P down. As far as liabilities go, this is a pretty valuable one! Discount it at any reasonable rate and it comes out to much less than $1m! I used 8% as a discount rate and got an actual value for the liability of ~$330k, a difference of ~$670k from book, once i discounted everything back. This may not sound like much, but that would add another $0.20 per share to SODI’s book value.

But the real value change comes from their tax assets. SODI has over $14m in net operating losses that are carried on their books at nothing. When SODI generates profits in the future, they won’t have to pay any taxes on them. All the cash flows straight through to corporate.

Remember that when I use EBIT, I’m using a pretax number so that we can compare valuations across companies. I use 8x because it’s very, very conservative- it’s basically equivalent to receiving a 12.5% rate on a bond (I will explain this “earnings yield” in a future post). Given that most companies would be paying taxes at a ~30% rate, I effectively use ~11.4x EBT multiple for most companies.

Because of their tax assets, SODI’s EBIT = EBT. So if we used my EBT multiple and applied it to SODI’s $1m in EBIT and then added cash back, SODI is worth ~$7.50 per share.

Finally, there’s a decent catalyst on the horizon. Pursuant to a settlement to one of their legacy liabilities, SODI agreed to pay $10k per year or 5% of any net income over $500k (which effectively means net income comes in over $700k) in FY 2009-2013. The kicker is that the company cannot pay any dividends until this liability is settled.

Given their massive cash position and the fact they don’t really have any investment needs, plus the age of their CEO, I think the company will most likely pay out a huge special dividend once the dividend restrictions are lifted, plus institute a regular dividend. Maybe they do a share buyback instead of the dividend, but either way, don’t scoff at the potential of this special dividend or buyback- the company has just under $3 per share in net cash and investments.

In other words, an investment in SODI has the potential to recieve a special dividend equivelant to 100% of the current share price within 2 years and still have an interest in a nicely profitable business!

One last note: one catalyst is likely off the table- a buyout. The firm could lose all of those potentially valuable NOLs in a change of control, so I don’t think they’d risk that by selling out.

Even without the buyout on the table, SODI seems like a no-brainer to me at these prices. I’ve added SODI to my growing basket of net-nets.

Disclosure- Long SODI, MPAD, and OPST. May add or sell at any time.



Stocks Discussed: SODI, MPAD, OPST,
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