Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement.
Most investors like to focus on earnings per share, margins, debt-to-equity and other traditional yardsticks to measure progress. But that’s not how successful entrepreneurs think. They think about cash, and specifically about watching it pile up in the bank. They hoard dollars until they’re ready to do something with them, like buy another company, expand or, most welcome to shareholders, pay dividends or retire shares.
The goal of a business, after all, is to create cash. With that in mind, investors should consider owning shares of Vecima Networks Inc., because not many companies do it better. And Vecima’s shares are dirt cheap.
Vecima has been making equipment for cable companies for 25 years. It’s a niche business – the company concentrates on a handful of core products that increase bandwidth and connect the last mile. The company also operates a high-speed wireless Internet provider.
This is what the business looks like to an investor: In the latest quarter, Vecima earned 11 cents a share on revenues of 97 cents a share. Gross margins were a solid 46 per cent, suggesting that there’s not a lot of competition in the space. Vecima will likely exceed its guidance for the year.
With a book value of about $6, and an intrinsic value that’s closer to $8, Vecima looks cheap at $5.40. Adjusting for cash, the stock looks cheap on a price-to-earnings basis, where it trades at a roughly 30-per-cent discount to other cable component suppliers.
Now, here’s how an entrepreneur might look at it. In the latest quarter, Vecima generated $10-million of free cash flow. In the past five years, the company has churned out more than $100-million of free cash flow and returned almost half that – or about $2 a share – to owners. That’s an awful lot of wealth for a company with a market cap of only $120.6-million.
But the story is even better than that. In December, Vecima paid out $1 a share to its investors. Despite that, it still has $37-million of cash in the bank and no debt. Cash from operations alone can take the cash balance north of $50-million by year-end, or more than $2 a share.
(Although it doesn’t pay a regular dividend, Vecima has a history of sending cash back to its owners periodically. Insiders, including family and friends, likely own 80 per cent of the stock, so the company has an incentive to distribute cash.)
The company also has another $16-million to $20-million of real estate it can sell (it sold property last year). Plus, the subsidiary providing wireless Internet service is worth $20-million to $30-million and, chief executive Sumit Kumar tells me, is not a core operation. I expect more asset sales, so the cash balance could reach $100-million if they occur this year.
Finally, Vecima has solid growth prospects, not only from its cable customers, who are trying to upgrade their systems to keep pace with the threat of Netflix and so on, but also from a new initiative in fleet management. That business tracks and monitors commercial trucks using proprietary technology.
Vecima only has about 1,000 vehicles signed up so far. Each brings in $30 a month, and roughly 90 per cent of that is profit. The industry is nascent and growing at 25 per cent annually. The company has an agreement with a truck manufacturer that builds 40,000 trucks a year but also has millions of trucks on the road that could be retrofitted.
If Vecima reaches 25,000 vehicles, that business will crank out about $7-million of cash per year. My guess is that would take about five years, if they carry out their growth plans.
So, how does such an extraordinary cash machine change hands for less than book value? The answers are simple: Few have heard of this quiet company, only one analyst covers it (he ranks it an “outperformer”) and insiders own too much stock, meaning it doesn’t trade with much volume. Illiquidity has a cost.
Still, you can rarely go wrong buying assets for less than they’re worth. In this case, the value can be unlocked through more special dividends, but also if the company’s insiders decide to sell some of their shares in an orderly fashion to improve liquidity.
Mr. Kumar tells me that is a possibility, but only when the stock price reflects the company’s value. When asked why Vecima is public, he tells me the issue of privatization comes up at pretty much every board meeting.
In the meantime, I own the stock because it’s cheap and because I expect another distribution this year. Eventually, the stock price will reflect the real value, which is increasing.