Solitron Devices (SODI, Financial) produces semiconductors, mainly for the US military. It trades slightly below (~20%) NCAV and cash is a big part of the balance sheet. The current assets are of really high value, because approximately 90% of the company's sales have been to customers whose products are sold directly to the US government. Therefore, I am not concerned about receivables and the value of inventory. The company also trades at an EV/EBIT multiple of just 4.6, even though the company earned a decent ROE in the past. Currently ROE is 7.7% and 18.6% if you exclude cash, but it has been much higher in the past.
Why is it cheap?
The cash is just sitting on the balance sheet, earning almost nothing. Since the CEO Chevach Saraf took over the company in 1992 and turned its operations around, he seems to try to keep the company safe from future problems by keeping the cash on the balance sheet. Of course shareholders want to get some of the cash paid out as dividends or see a share buyback, but Saraf doesn't really care about outside shareholders. There even hasn't been an annual meeting for some years until Nate Tobik from oddballstocks forced management to change their minds. The board also clearly is in favor of Saraf.
Take John F. Christe for example, who was a director at Forward Industries, where insiders issued preferred stock at a substantial discount to indsiders and their friends and also unjustifiably increased the annual rent that benefitted the Board Chairman. I don't like Christe (why the hell do I always think of a woman when I hear Christe?) to be on the board of SODI and certainly other shareholders don't like him neither. Saraf also owns quite a lot of shares and ignores other shareholders, which is why it's hard to change the board.
Why I like it anyways
The company's operations are pretty good and Solitron also possesses a small moat in their niche. You may wonder how a semiconductor company can have a moat. Well, SODI mainly sells outdated semiconductors to the US military. Since they already are in business for quite a while, they have good relationships to their customers and really know how to operate in this niche. Because the company mainly sells to the military, there is almost no foreign competition, which would result in lower returns. SODI also is able to pass additional costs on to the government quite easily, so there is very little risk in the business.
The company also had to pay back some environmental liabilities (pre turnaround), which were fully paid back in 2013.
Additionally, Solitron also has Net Operating Losses of over $14 MM that expire in 2031. If Saraf would do a great acquisition, those NOLs could enhance value tremendously. However, I don't expect him to do any good acquisitions and I prefer to see the cash on the balance sheet instead of doing a dumb acquisition.
Activist investors might also buy a substantial stake in the company, which would make the NOLs worthless. Saraf also has a poison pill installed, which could increase his share of the company too much and the NOLs would expire subsequently. So I valued the NOLS at zero, however I look at the NOLs as some kind of a free option.
Speaking of activists, some fellow value investors started to talk to Saraf about better ways to allocate the cash. Apparently, he ignores most of the proposals. I would love to see a serious proxy fight, but I expect it will take much more time for things to work out.
If the company pays out the cash, ROE would have been at ~19% in 2014 and therefore the stock certainly would trade at a significant premium to book. Management mentioned that most of the assets are already fully depreciated, but are still in use, which is one of the reasons why SODI earns such a high ex cash ROE in such a lousy industry.
Even though Saraf apparently isn't the best capital allocator, he really understands the industry and knows how to negotiate good deals with the customers.
Risks
There is almost no risk for the company as a going concern. I am just a little anxious about Saraf. He might exercise his options, which will give him about 30% ownership of the company so it will be even harder for outside investors to force changes and he would dilute shareholders substantially as well. I am also afraid that he does something dumb with the cash, like an overpriced acquisition. I don't want to see management spend too much on capex either. However, the company grows its intrinsic value over time and there are some potential catalysts, which could unlock value.
Outlook
I don't expect a multiple expansion soon, since there are some serious management issues. If the company finally pays out the cash and we use a PE multiple of 15, the upside is ~120%. My hole thesis relies on the huge cash pile and what will happen to it. Nevertheless, the company will do fine over the next few years, so at least I am not concerned about a decline in intrinsic value. I don't expect my thesis to play out quickly, it certainly will take a few years. Anyway, I expect the intrinsic value to increase by at least 7% over the next few years, because ROE grew by at least 7% in the last eight years. Thus I am willing to wait for something good to happen for quite a while.
