I wrote about DGT Holding Corp (formerly Del Global Technologies Corp) (OTC:DGTC) back in March. The company trades over the counter, but continues to file with the SEC (here) and does so with the transparency one would expect to find only in public companies, so I am less worried about DGTC than I would be about a similar OTC stock. (I found the same thing with Conrad Industries, which trades in the pink sheets but has superb disclosures and regular filing).
The company develops, manufactures and markets medical imaging systems (via its Villa subsidiary in Italy) and power conversion equipment (via its RFI subsidiary in the US), and appears at first glance to be a good value prospect. The company trades for a market cap of around $31 million (as of 7/13), but its current assets less total liabilities (Net Current Asset Value, or NCAV) is equal to $33.4 million.
DGT Holding Corp capitalization, 2001 - 3Q 2011
As you can see, the company’s cash levels (the purple bars) have grown dramatically in the last year to reach all-time highs, and debt (the blue bars) has fallen quite dramatically to all-time lows. Unfortunately, it is important to look at how the company built this cash hoard.
In November of 2010, the company executed a rights offering, allowing shareholders the right to purchase 1.1004 new shares for $0.60. In doing so, the company sold 24,999,224 shares (the maximum allowed under the offering including oversubscription rights). So, unlike other companies we’ve looked at, DGTC’s cash balance is derived not from Cash Flows from Operations, but rather Cash Flows from Financing, which is less exciting because it is less likely to be reproducible in the future.
That said, it is still worth considering the fact that, if the company distributed say 80% of its $22.8 million in cash, investors would be getting the business for about $15 million.
What does $15 million get you? Let’s look at the company’s historical returns.
DGT Holding Corp returns, 2001 - 3Q 2011
The company performed poorly at the start of the decade, and has been performing somewhat better since then, but overall this is nothing to get excited about. However, for such a small company, even minor issues can have a major effect. When reviewing the company’s financials, it becomes clear that their returns have been hurt by past litigation (with senior executives regarding compensation), and they have taken charges related to the sale of different divisions. Many of these one-time charges were non-cash, so let’s look at their free cash flow history.
DGT Holding Corp free cash flows, 2001 - 3Q 2011
Unfortunately, given the company’s size its free cash flows are highly volatile (the result of swings in working capital that are not uncommon among smaller companies), providing very little to rely upon. One good point is the fact that the company’s capital needs are relatively low, averaging just 2/3 of depreciation charges over the decade.
One more thing before I get to valuation. The company appears to have a built-in catalyst in the form of a motivated shareholder – Steel Partners Holding LP – which has been actively increasing its position in the company and now has representatives in the positions of CEO & President (John Quicke) and Chairman (James Henderson). Steel Partners recently purchased the shares of another large shareholder, Grace & White, pushing SP’s holding to 51.1%. Clearly management and the board aren’t going to be slacking off with this much invested (though, there is always the risk that the company starts operating for the benefit of SP, at the expense of smaller shareholders). SP may very well prove to be a value-unlocking catalyst for DGTC shareholders.
In valuing the company, I used longer-term average margins, adjusting for more weight on recent years to account for past divestitures. I found that the company does appear quite cheap, even in the bearish scenarios.
You are thinking “Why would you pass on a company that looks cheap, has liquid and easily valued assets, and has a built-in catalyst?”
The problem here is that company’s valuation is largely driven by the fact that its enterprise value is so low (recall the massive cash hoard and low debt). This means an investor is relying on the cash being available for distribution, which may prove to be an inappropriate assumption. From the company’s press release prior to the rights offering (1Q 2011):
What do you think about DGTC?
Author Disclosure: None
Talk to Frank about DGT Holdings Corp
The company develops, manufactures and markets medical imaging systems (via its Villa subsidiary in Italy) and power conversion equipment (via its RFI subsidiary in the US), and appears at first glance to be a good value prospect. The company trades for a market cap of around $31 million (as of 7/13), but its current assets less total liabilities (Net Current Asset Value, or NCAV) is equal to $33.4 million.
DGT Holding Corp capitalization, 2001 - 3Q 2011As you can see, the company’s cash levels (the purple bars) have grown dramatically in the last year to reach all-time highs, and debt (the blue bars) has fallen quite dramatically to all-time lows. Unfortunately, it is important to look at how the company built this cash hoard.
In November of 2010, the company executed a rights offering, allowing shareholders the right to purchase 1.1004 new shares for $0.60. In doing so, the company sold 24,999,224 shares (the maximum allowed under the offering including oversubscription rights). So, unlike other companies we’ve looked at, DGTC’s cash balance is derived not from Cash Flows from Operations, but rather Cash Flows from Financing, which is less exciting because it is less likely to be reproducible in the future.
That said, it is still worth considering the fact that, if the company distributed say 80% of its $22.8 million in cash, investors would be getting the business for about $15 million.
What does $15 million get you? Let’s look at the company’s historical returns.
DGT Holding Corp returns, 2001 - 3Q 2011The company performed poorly at the start of the decade, and has been performing somewhat better since then, but overall this is nothing to get excited about. However, for such a small company, even minor issues can have a major effect. When reviewing the company’s financials, it becomes clear that their returns have been hurt by past litigation (with senior executives regarding compensation), and they have taken charges related to the sale of different divisions. Many of these one-time charges were non-cash, so let’s look at their free cash flow history.
DGT Holding Corp free cash flows, 2001 - 3Q 2011Unfortunately, given the company’s size its free cash flows are highly volatile (the result of swings in working capital that are not uncommon among smaller companies), providing very little to rely upon. One good point is the fact that the company’s capital needs are relatively low, averaging just 2/3 of depreciation charges over the decade.
One more thing before I get to valuation. The company appears to have a built-in catalyst in the form of a motivated shareholder – Steel Partners Holding LP – which has been actively increasing its position in the company and now has representatives in the positions of CEO & President (John Quicke) and Chairman (James Henderson). Steel Partners recently purchased the shares of another large shareholder, Grace & White, pushing SP’s holding to 51.1%. Clearly management and the board aren’t going to be slacking off with this much invested (though, there is always the risk that the company starts operating for the benefit of SP, at the expense of smaller shareholders). SP may very well prove to be a value-unlocking catalyst for DGTC shareholders.
In valuing the company, I used longer-term average margins, adjusting for more weight on recent years to account for past divestitures. I found that the company does appear quite cheap, even in the bearish scenarios.
You are thinking “Why would you pass on a company that looks cheap, has liquid and easily valued assets, and has a built-in catalyst?”
The problem here is that company’s valuation is largely driven by the fact that its enterprise value is so low (recall the massive cash hoard and low debt). This means an investor is relying on the cash being available for distribution, which may prove to be an inappropriate assumption. From the company’s press release prior to the rights offering (1Q 2011):
In addition, we anticipate closing the $15 million rights offering before the end of the calendar year. This will provide the capital to allow us to consider strategic acquisition alternatives to complement the Company’s organic growth plans.From their second quarter 2011 press release:
In addition, we completed the $15 million rights offering before the end of the calendar year. This will provide the capital to allow us to consider strategic acquisition alternatives to complement the Company’s organic growth plans. We are actively pursuing power system acquisitions in the U.S.Then from their press release last quarter:
We are actively pursuing acquisitions in the U.S. market.It is clear that the company is going to use this cash for acquisitions, which is sensible from their perspective (after all, why raise money in a rights offering only to return it to shareholders?). However, knowing that this is the case, an investor is left with considerable uncertainty as to what the company’s future performance might look like. An acquisition, depending on the size and deal structure, may drastically change future margins, capital demands, and could add debt with associated fixed interest payments. For these reasons, I find DGTC too risky for my portfolio.
What do you think about DGTC?
Author Disclosure: None
Talk to Frank about DGT Holdings Corp
