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Earnings Preview: Lufkin Industries (LUFK)

July 11th, 2008 by Yehuda Fruchter | No Comments

Introduction
Lufkin Industries (Nasdaq: LUFK, Market Cap.: $1.1 billion) is an oil services stock that could move 50% higher by year end. Importantly, the first catalyst for an improving share price may come next week when the company announces second quarter fiscal 2008 earnings. We believe that the upcoming report will finally be the start of renewed earnings momentum at the company after nearly two years of sluggish growth on the back of the disappointing results of the company’s non-energy related trailer business. Importantly, LUFK discontinued the non-energy related trailer business in January 2008, and this will be the real first quarter without the drag of this division, allowing the booming oilfield service and power transmission markets to really improve the bottom line.

The favorable earnings comparisons could boost the shares at a time when many investors are scouring for reasonably valued oilfield service shares following the excellent performance of oilfield service shares over the last few years. LUFK is only one of a handful of oil service shares that appears reasonably valued on an absolute basis, and significantly undervalued on a relative basis. Notably, LUFK is sitting on $100 million in cash and has no debt.

Company Background
LUFK was founded in 1902 and is primarily known for designing, manufacturing and marketing the industry standard conventional, Mark II and other rod lift pumping units that are used to lift oil from wells. However, the company actually currently operates in two broad divisions: Oilfield Services and Power Transmission (actually the fastest growing division at LUFK increasing 27% in 2007 over 2006).

The oilfield services business manufacturers pumping units, as mentioned, however, LUFK also provides additional oil services equipment and services.

The Power Transmission Division, makes precision-made gears in weights from 300 pounds to 250 tons and in power levels from 20 to 85,000 horsepower. These highly engineered products are used in industrial applications in a variety of industries, such as oil and gas, petrochemical, steel, plastics, sugar, rubber, marine and power generation.

What Went Wrong at LUFK?

Basically LUFK has suffered from two major problems: A slowdown in its largest business, i.e. pumping units in the North American market, and the poor performance of the company’s former trailer division.

As regards to the North American market, LUFK had this to say in its 10-K:

During 2007, demand in the North American market has been negatively affected, compared to 2006 levels, by the impact of lower natural gas prices on coal-bed methane and other unconventional gas production that use rod pumps to de-water wells, drilling program delays from M&A activity, cost control efforts deferring or reducing capital spending programs and the competitive pressure from lower-priced pumping units in areas traditionally served by the used unit market.

What Has Changed?
Two significant changes have eliminated the problems mentioned above, and augur well for LUFK’s future operating results.

1. LUFK Discontinues the Trailer Division

As noted in LUFK’s 10-K:

Due to these market conditions, in January 2008, the Company announced the decision to suspend its participation in the commercial trailer markets and to develop a plan to run-out existing inventories, fulfill
contractual obligations and close all trailer facilities during 2008.

As noted in the recent 10Q:

During the first quarter, all remaining trailer orders were manufactured and the manufacturing workforce was redeployed throughout the Company or terminated. Also, several service centers were closed and the inventory was consolidated at the Lufkin, Texas facility for future aftermarket sales. During the second quarter of 2008, it is expected that the remaining backlog of trailers will be sold, the manufacturing facility will be closed, with any remaining equipment sold, and the remaining service center will be closed and consolidated into the Lufkin, Texas facility. The Company is exploring options for serving the future aftermarket parts business and fulfilling contractual warranty obligations.

2. Due to Sustained High Oil and Natural Gas Prices The North American Market is Picking Up

Based on information provided by LUFK and it’s main competitors (i.e. WFT), the North American market is picking up steam.

As noted in LUFK’s recent 10Q:

During the first quarter of 2008, demand levels in North America increased over the levels experienced in the latter half of 2007 as higher energy prices drove increased drilling and workover activity. Additionally, the demand for pumping units, oilfield services and automation equipment continues to increase in international markets. While a majority of the segment’s revenues are in North America, international opportunities continue to increase as new drilling increases and existing fields mature, requiring increased use of pumping units for artificial lift, especially in the South American, Russian and Middle Eastern markets.

Oil Field’s backlog increased to $97.1 million as of March 31, 2008, from $58.1 million at March 31, 2007, and $76.9 million at December 31, 2007. This increase over the December 31, 2007, level was driven by increased bookings for new units for the U.S. market as higher energy prices drove increased drilling and workover activity. The increase over the March 31, 2007, level also reflects the growth of international orders for new units.

Valuation (Upside Case)
I’ll keep this valuation part very short, since the case for LUFK is quite simple. Basically, we believe that by next quarter, LUFK will be on a run rate of $1.50 per share in earnings on a quarterly basis. This works out to $6 per share earnings power on a yearly basis. The best comp for LUFK is WFT, which trades at approximately 20X earnings or so (higher if take other factors into consideration). Given LUFK’s solid growth potential in the coming years, particularly for the company’s lesser known power division, I see no reason why LUFK will not trade at 20X multiple (including $7 per share in cash) once earnings growth resumes. That leads to my target price of $120 on LUFK in the year ahead.

Note: If you go thru LUFK’s past financial statements, you’ll notice that the earnings basically equal the free cash-flow for the company and that the company has been a solid cash generator for years.

Risks
The risk for LUFK is the same as that faced by any other energy-related issue, namely the risk of a significant decline in oil and/or natural gas prices. Obviously, we have no idea where energy prices will head in the coming year, but our strong belief is that even at lower prices the demand for oilfield and power transmission equipment, will still be very high and LUFK will have no trouble maintaining strong cash-flow. If oil prices completely collapsed (say to $50), in the next six months, then of course all bets are off. But we think the odds of that happening are extremely low.

Incredimail’s Stock (MAIL) Could Get A Boost

July 9th, 2008 by Yehuda Fruchter | No Comments

Introduction
Incredimail (Nasdaq: MAIL, Market Cap.: $32 million) is a decent speculation at current prices or lower. My optimism for the shares, at least over a short-period of time, is driven by the fact that the shares remain over 60% below their highs, and yet three positive pieces of news were recently delivered that seemingly could boost the stock price.

Specifically, in the last few weeks: MAIL signed a direct agreement with Google, announced the re-pricing and forfeiture of various options, and perhaps, most importantly, SEC filings indicate the culmination of selling by the company’s largest outside shareholder. Notably, the downside risk in the stock seems minimal at current prices given that nearly 75% of the market cap is in cash (MAIL has no debt), and the valuation measures seem very low (i.e. Enterprise Value (EV) relative to TTM Sales of 0.5X, and EV/Free Cash-Flow Potential of a mere 5X).

Company Background
MAIL basically provides some gimmicky free email services that have attracted about 10 million users. The company makes money by selling some premium products (e.g. a spam filter product), and increasingly via advertising thru Google’s AdSense program (a mostly automated Pay-Per-Click (PPC) advertising program). My own personal opinion is that Google’s Adsense program is one of the greatest businesses going right now worldwide, and I’m always interested in investing in businesses that can generate significant revenue via the program. There is obviously a ton of competition for MAIL’s service, but the fact remains that the company has already attracted a huge amount of users allowing it to generate about $9 million in advertising revenue in 2007, nearly four times what it did the year before.

Financial Facts concerning MAIL are available at this link:

What Went Wrong at MAIL?
In early 2008, Google abruptly decided to stop its Adsense partnership with MAIL, leading to a collapse in MAIL’s stock price as Adsense is the company’s primary, and most profitable, revenue stream. Though Google soon reinstated MAIL back into the Adsense program, there was still concern over the initial Google ban and a fear that the company could lose Google Adsense over the long-term.

In addition, to the Google mishap, MAIL did have a fair amount of auction rate securities (nearly $5 million) on its balance sheet which it needed to write off in 2007. This write off effected reported earnings and, like many other tech companies with large cash positions, has cast some doubt as to the value of the company’s other cash holdings. For more on the cash situation, please see the “Risk” section below.

What Has Changed?
The Google mishap led to a management shakeup at MAIL, and the start of renewed negotiations with Google. In early July 2008, MAIL finally announced the signing of a Google Adsense direct agreement, which I think completely allays the fears over the future of the Google business and removes a large amount skepticism related to MAIL’s ongoing viability.

In addition, to the Google announcement I also noticed that one of the largest sharholders of the company, LongView Fund, who was sitting on a major loss in MAIL’s stock finally dumped all of their remaining shares at about $2.60. The culmination of selling by a large shareholder removes the selling pressure in MAIL’s stock, and should help the upside when and if good news is announced.

Finally, just the other day, MAIL announced another repricing of options for key employees that I thought was quite revealing. Namely, the company moved up the strike price from $3 to $3.75 and cancelled the options of the CEO.

Valuation

As for the valuation of MAIL, I think the repricing of options to $3.75 strongly reveals management’s view as to the downside value of the stock and the potential for a nice gain from those levels.

From a financial perspective, please see this link:
to the financial figures below for MAIL where I list certain key figures for the company.

My feeling is that a company that is growing revenues at a double digit rate, has gross margins of 90%, and almost no cap-ex, is extremely undervalued selling at 0.5X revenue and less than 3X EBITDA. Of course this valuation reflects lingering skepticism towards MAIL, its management team, and its business model.

On the upside, though, should MAIL demonstrate some renewed financial momentum and should investors regain trust in the business, it would appear that the stock could easily double, at which price the shares would be trading at about 2X revenue and a little over 10X TTM EBITDA, both reasonable values for this company. I would note that I use TTM EBITDA as the benchmark for the company’s EBITDA and FCF potential and hence upside valuation since the recent earnings report was somewhat disappointing due to some one-time write offs and a large uptick in R&D as the company is nearing the launch of some new products.

Risks

The major risks for MAIL are:

Cash Value: In looking at the most recent 20-F, it would appear that the company has entirely written off the auction rate securities and the vast majority of the remaining cash ($17 million or so), is invested in corporate debt securities which have an active market. However, I can not be completely sure as to the ultimate liquidity of these holdings and/or whether the company can readily convert these to cash. My assumption is that the Auction Rate security debacle has probably refocused CFO’s and that the remaining cash is liquid.

Ongoing Business: While the company can generate nice gross margins off the Adsense business, the issue is whether management will bring those dollars to the bottom line or whether they will waste the profits on new endeavors that will never pay off. The risk of this type of situation is not all that remote given the large uptick in R&D expenses in the most recent quarter, reflecting the upcoming release of new products as detailed in the company’s earnings release. Of course, if AdSense revenue continues to grow, these additional expenses will be negligible, but investors need to pay close attention to upcoming financial reports and sell on any indication that profits are being sucked out of the business, instead of flowing to the bottom line. It may take a few quarters to get a sense of the financial direction of the company.

Disclosure: I am currently long shares of MAIL and I may buy and sell shares at any time without telling you about these actions. I do not have any obligation to share with you any updated information about MAIL in the future.
All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Funding for Polysilicon-Based PV Manufacturers: A Look at Four Companies

July 6th, 2008 by Yehuda Fruchter | No Comments

In this post we will take a look at the future capital needs and funding requirements of four Chinese polysilicon-based PV Manufacturers.

Briefly, our conclusion, based on current low cash levels, high outstanding short-term debt as a percentage of total capital, and future capital needs, in the form of outstanding purchase obligations listed in recent 20-F filings, is that nearly all of the companies mentioned here will have a significant weakening of balance sheets in the near term, as short-term debt levels soar to support growing operating cash losses and purchase obligations. The prospect of immediate dilution via direct equity share offerings is clearly remote, as past history shows that these companies prefer to use convertible debt issues, as opposed to straight equity, as a longer-term financing vehicle.

Note: Subscribers can access spreadsheets on the company’s mentioned in this report by visiting this link:
http://spreadsheets.google.com/pub?key=pb-Z9URIzMG0KVo0cCO7QZw
We will update this link as earnings seasons progresses, as well as add additional companies, as time permits.

The current method of financing for these companies, in the absence of converts, is short-term bank loans from local Chinese banks, with much of these loans secured by related parties. The growing balance of short-term loans is apparently not seen as risky, even when they approach high levels of total capital, since these companies have, in the past, been able to quickly flip these loans into longer-term convertible issues, when, and if, share prices recover for short periods.

This ponzi-like cycle of financing can, in theory, continue indefinitely, until foreign investors become concerned about the continued cash losses, and deteriorating balance sheets. At that point business models may be questioned, share prices could plummet further, and investors could refuse to participate in the longer-term financings to replace the local bank loans. Chinese banks may conceivably continue to support these companies, but ironically their seeming refusal to currently finance these companies on a longer-term basis, does not bode well for their willingness to offer longer-term financing in the future if cash becomes scarce from foreign investors.

Alternatively, it’s conceivable that some of these polysilicon-based PV Manufacturers will secure enough financing to survive until they become self-sufficient on an operating cash-flow basis. However, as noted in past reports, the nature of the business implies that operating self-sufficiency is far off into the future for all these companies and given their position in the solar supply chain may, in fact, be a “pipe dream”.

Interestingly, though the “polysilicon supply/price situation will ease soon” meme appears to resurface every once in awhile, supporting improved cash-flow projections, it’s unclear where the source of optimism originates from. Every single 20-F from each of the mentioned manufacturers, and others, projects continued polysilicon shortages and high poly prices for the foreseeable future.

In sum, we continue to advise investors to avoid the shares of all of these Chinese polysilicon-based PV Manufacturers , until specific financing is announced and the longer-term financing and negative cash-flow issues facing these companies is addressed.

And now onto specific companies:

Trina Solar (TSL):

TSL is currently the company that is most heavily reliant on short-term financing, with $322 million in short-term loans as of May 2008 (see page 58 in 20-F), up an incredible 100% from $160 million at year end 2007. The current short-term debt figure represents nearly 50% of the company’s total capital. TSL had $38 million in cash as of 3/31/2008, but that cash level has been increased via the recent boost in short-term loans.

With an Envoy estimated 2008 EBITDA of approximately $145 million, and purchase obligations of roughly $245 million this year (including cap-ex), and $217 million in the next 1 to 3 years (page 58 in 20-F), we estimate that TSL has a funding gap of at least $180 million in the coming year. (Note that due to accounts receivable, and other financing, issues as discussed in previous posts, not all estimated EBITDA can be used for capital purposes).

As noted above, since TSL has already secured nearly $160 million in short-term financing already this year, it would appear that the company will probably only need to raise an additional $50 million or so in the next six months to support operations.
However, given the company’s already high level of short-term debt, one wonders how much more debt the local Chinese banks will lend to TSL. More importantly, it’s unclear why these banks will care to hold onto this debt, particularly given the prospects of continued cash losses for TSL in 2009. As such, it seems highly unlikely that TSL can carry such a high balance of short-term loans for much longer and the company must surely be facing pressure to refinance these loans. As such, we expect a convertible offering from TSL in the coming months, which will be used to pay off these short-term loans.

The higher proportion of short-term financing as a percentage of total capital, could be the reason for TSL’s lower valuation relative to the others in the group. At current prices, TSL trades for an Enterprise Value or EV (Market Cap – Cash + Debt) to estimated 2008 EBITDA of about 6.5 and EV/Sales of 1.2X. (Note: The level of debt at these companies necessitates an enterprise valuation, and market cap valuations, such as P/E’s, which do not take current and future debt levels into consideration, are highly misleading and unjustifiable).

Canadian Solar (CSIQ)

CSIQ has the highest relative valuation of the current group of companies, and at the same time highest purchase obligations in the next 1 to 3 years.

As of 3/31/2008, CSIQ had total debt of about $90 million ($71 million in short-term debt, up from $40 million at year end 2007) and $32 million in cash, taking into consideration the conversion of the company’s previous $75 million of convertible notes, which added about 4 million shares to the company’s share count.

Though, CSIQ’s total debt is still relatively low as a percentage of total capital, that situation will surely change dramatically in the coming weeks or months. That is because, CSIQ has $338 million in purchase obligations (including cap-ex) this year and an additional whopping $632 million is due within 1 to 3 years (see page 60 in CSIQ 20-F). As noted above, the company had a mere $32 million of cash as of 3/31/2008, to support these obligations. Moreover, CSIQ recently upped its cap-ex budget for 2008, so our estimates above could prove to be too low.

With an Envoy estimated EBITDA in 2008 of about $115 million, and increasing accounts receivable growth, we believe that CSIQ is need of at least $320 million relatively quickly, in order to support operations. It will be interesting to see how the company plans to finance these cash needs when the next earnings report is announced. If we had to guess, the company is currently being held on life support by Chinese banks until a very large convertible can be completed on Wall Street.

At over 10X EV/2008 Est. EBITDA and 1.5X EV/2008 Est. Sales (EV is calculated using the additional 4 million shares from the recent Note conversion), the shares appear quite expensive, especially considering the near-term financing issues.

Solarfun (SOLF)

As of 3/31/2008, SOLF had $85 million in cash, and $339 million in total debt ($143 million short-term and $172 million in converts due in 2018).

With an Envoy estimated $95 million in 2008 EBITDA, and nearly $550 million in purchase obligations (includes $150 million in cap-ex) in the next year and $350 million in the next 1 to 3 years (see page 65 in SOLF 20-F), we think SOLF is on the hook for at least another $400 million in 2008.

Given SOLF’s already high debt level as a percentage of capital and lower EBITDA prospects as compared to the CSIQ and TSL, we think the financing of $400 million for SOLF will be quite tricky in the months ahead. Luckily, the company completed a large convertible earlier this year, and the cash proceeds could conceivably support the company for one more quarter or two. After that, expect another large convertible.

At over 9.5X EV/2008 Est. EBITDA and 1.3X EV/2008 Est. Sales, the shares appear expensive and we have strong doubts about SOLF’s long-term viability given the already high debt level.

Yingli Enery (YGE)

YGE is seemingly the most vertically-integrated of the companies mentioned in this post, and therefore reports the highest reporting operating margins of the group. Nevertheless, despite the relatively better operating profile, the company is not immune to the cash-flow issues facing the industry.

As of 3/31/2008, YGE had $80 million in cash, and $290 million in total debt ($115 million short-term and $175 million in converts).
With an Envoy estimated $200 million in 2008 EBITDA, and nearly $585 million in purchase obligations (includes cap-ex of about $275 million), in the next year and $150 million in the next 1 to 3 years (see page 98 in YGE 20-F), we think YGE requires about $450 million 2008.

Given YGE’s lower overall debt level as a percentage of total capital, higher estimated EBITDA and lower capital needs looking out 1 to 3 years, it would appear that the company may have a somewhat easier time raising appropriate financing than the other companies mentioned in this report.

However, at about 10X EV/2008 Est. EBITDA and 2X EV/2008 Est. Sales, the shares appear to already reflect the company’s better relative positioning and financing “breathing room”.

Conclusion
In conclusion, for TSL, CSIQ, SOLF, and YGE, the same story should play out over the next few months and year. Balance sheets will continue to deteriorate as debts pile up to support operating cash losses (due to previously mentioned raw material purchase obligations and higher accounts receivables) and cap-ex. At some point, foreign investors will tire of financing these companies, particularly since none have them have any particularly unique/defensible technology and/or pricing power. Investors should continue to be suspect of valuations of these companies that utilize accounting earnings and revenues, and instead should focus more on operating cash-flow, balance sheets, financing options, and future purchase obligations.

Clarifying The Financial Issues Facing Polysilicon-Based PV Manufacturers

July 3rd, 2008 by Yehuda Fruchter | No Comments

In this post, I will address the two most common criticisms of our article last month on several polysilicon-based PV manufacturers and thereby hopefully clarify the financial issues that confront many of these polysilicon-based PV manufacturers.

Before getting to the criticisms, though, it is important to note that nearly all of the comments to the post fail to distinguish between cash outflows due to capital expenditure requirements and cash-outflows due to working capital management. However, these are two entirely different issues.

If the significant cash losses for some of the polysilicon-based PV manufacturers were just due to significant cap-ex needs, there would really be no major cause for concern as it would be a natural outcome of their growth and need to meet future capacity.

The issue, though, is that many polysilicon-based PV manufacturers have significant cash outflows even before cap-ex needs and it is this problem which needs to be addressed, especially considering the mismatch between positive accounting earnings reports and this negative cash-flow before cap-ex. Basically, the existence of significant cap-ex needs merely aggravates an already tenuous cash-flow situation, but it is not the major problem in itself.

As noted in the original post, when looking at several of these polysilicon-based PV manufacturers, it is clear that the main reason for these cash outflows before cap-ex, is due to the fact that these companies need to shell out huge amounts of money to suppliers of polysilicon, well in advance of receiving any actual cash revenue from customers. As these payables are dramatically increasing, the competitive dynamic of the industry is causing much greater use of longer-term credit-based sales resulting in very high accounts receivables growth. It is in fact questionable whether certain types of longer-term credit sales should even be recognized as revenue.

This is the crux of the working capital cash issues and given the competitive nature of the industry and still very tight supply of polysilicon, it is a situation that would seem to be getting worse, rather than better.

With that said, we can now move onto the two most common critiques:

Criticism I: Every Young Business That is Growing Rapidly Drains Cash

Answer: Obviously, young and fast-growing companies in any manufacturing-based industry will need to expend cash in building out infrastructure to support the production of products and future demand. However, as noted above, the issue here is not about cash drains due to cap-ex, but due to working capital cash outflows, i.e. cash negative outflows before cap-ex.

There is not one shred of evidence or any economic rationale to the assertion that fast-growing companies should lose cash before cap-ex after they reach a certain sales level. I’m not sure how anyone can assert that a company nearing a reported $1 billion in sales, needs to burn thru tons of cash before cap-ex needs and yet at the same time report extraordinary accounting earnings gains. In fact, just to put this criticism to rest, one counterexample, in the same exact industry, should suffice.

The most valuable company in the solar space now is the thin-film manufacturer, First Solar (FSLR). First Solar is growing as rapidly as any polysilicon-based manufacturer, and yet it’s operating cash-flow, before cap-ex, is solidly in the black and has been for quite some time. Interestingly, as opposed to many polysilicon-based manufacturers, First Solar makes it quite easy to track cash flows into the company, as it reports its cash flow quite simply as Cash Received from Customers and Cash Paid to Suppliers and Employees.

Criticism II:
The Solar Industry Is Growing Rapidly and Therefore The Concerns Regarding polysilicon-based PV Manufacturers Is Misguided

Answer:
Apparently, many readers took the concerns raised against polysilicon-based PV manufacturers as an attack on the entire solar industry. However, this was not the intent of the article.

Even if one believes strongly in the secular growth of the solar industry, as I personally do, it is obvious, based on past business history in every other major growth industry that ever existed, that many of the companies participating in the industry will simply go bankrupt or fail to provide any return to shareholders for various reasons. There are countless recent examples of this (i.e. fiber optic component suppliers) economic reality.

The fact is that a growth of an industry does not benefit all players in the industry’s ecosystem, as certain business models simply don’t have economic viability and many companies fail to receive adequate financing.

In regards to the solar industry, despite the secular growth, investing in many polysilicon-based manufacturers in the current environment may turn out to be a losing bet. The situation could, of course, change if a wave of merger activity goes thru sector, consolidating the power of the industry into a few large companies, and thereby the improving the negotiating strength over suppliers and customers and eliminating much of the working capital cash issues.

In conclusion, the solar industry presents some very attractive investment opportunities, but investors still need to focus on those companies that can at some point be self-funding on an operating basis, and have a unique technology that reduces competitive pressures.

In the case of many polysilicon-based PV manufacturers the cash outflows raise serious and real financing concerns and it is incorrect to value these companies off of accounting earnings and revenues. It will be paramount for investors to gain a clearer understanding of these companies polysilicon agreements and customer credit/sales terms, two facts that are not often disclosed in public filings, but should be addressed by management.

ATS Automation Tooling Systems (ATA.TO) Restructuring Shows Evidence of Success: Does the Stock Still Have Upside?

July 1st, 2008 by Yehuda Fruchter | No Comments

In this post, I’ll take a look at ATS Automation (ATA.TO or ATSAF.PK ), a Canadian company that primarily specializes in providing automated manufacturing systems to various sectors, including the fast-growing alternative energy industry. In addition, the company also owns PhotoWatt France, a provider of photovoltaic solar modules and is a leader in the manufacture of refined metallurgical silicon (UMGSi) silicon cells and modules. UMGSi a lower grade of silicon that can be acquired more readily than polysilicon.

ATS Automation has been in restructuring mode since September 2007, when a group of shareholders successfully ousted past management and installed a whole new leadership team. Recently, the company’s fourth quarter fiscal 2008 financial results demonstrated significant financial improvements and a strong outlook for fiscal 2009, prompting me to take a closer look at the company. Although the stock has appreciated dramatically from its low earlier this year, I still believe that ATS Automation (ATA.TO – PinkSheets), has significant upside (100%) in the next one to three years.

Summary: Why Is ATS Automation (ATA.TO) a Potentially Attractive Speculation

The following criteria combine to imply that ATA. TO shares have low risk and attractive upside over the next one to two years:

Depressed Price: Although the stock has appreciated dramatically from its low earlier this year, when there appears to have been some liquidity concerns, it is important to note that ATA.TO is still significantly lower than its high of nearly $18 back in April 2006 and is still well below prices that were reached over five years ago.

Corporate Restructuring and Divestitures: Over the last six months or so, the company has significantly restructured its workforce and started to divest significant asset holdings, including an entire business division. Details can be found in the last MD&A report, here: http://www.atsautomation.com/profile/investors/pdf/ATS%202008%20Annual%20MD&A.pdf

Attractive Industry Dynamics: As will be detailed further below, both of ATA.TO remaining operating subsidiaries have significant exposure to the high growth alternative energy sector.

Improving Financials and Year-Over-Year Comparisons: As can be seen below, ATA.TO’s fiscal 2008 fourth quarter demonstrated significant profitability improvements and top-line growth prospects, implying that in the coming year the company’s financial reports should show significant improvements and growth.

Low Valuation: As I’ll show below, despite the recent rebound in its shares, ATA.TO is still a cheap stock based on potential EBITDA assumptions. On an even more simplistic level, ATA.TO stock trades at an EV/Sales ratio of less than 1, despite improving profitability ratios and a strong sales outlook.

Healthy Balance Sheet: ATA.TO has a net cash position and little debt.

Seemingly Unknown to Most Alternative Energy Investors: Despite investor fascination with alternative energy plays, particularly the Chinese solar companies which I wrote negatively about in a previous post, I have seen little to no mention of ATA.TO as a solid alternative energy play in any popular media or top tier Wall Street analysts reports.

Continued Good News Over The Next Year Creates Positive Feedback Loop Over the next year, I believe that ATA.TO will continue to report solid financial results and could in addition release exciting strategic news, including additional partnerships for PhotoWatt, the sale of the company’s discontinued operation, as well as additional alternative energy contracts for the company’s main ASG subsidiary. Combined all of these news items should help to create a positive feedback loop for the company and the stock.

Company Background

ATS Automation Tooling Systems Inc. (“ATS” or the “Company”) operates in two segments:

Automation Systems Group (“ASG”) is an industry-leader in planning, designing, building, commissioning and servicing automated manufacturing and assembly systems – including repetitive equipment manufacturing and test solutions – in the worldwide market for healthcare, computer-electronics, automotive, energy and consumer products automation. Interestingly, the fastest growing segment of ASG is in the solar and nuclear manufacturing automation markets.

Photowatt Technologies includes Photowatt France, a vertically-integrated manufacturer of ingots, wafers, solar cells and solar modules. Photowatt France has developed processes and technologies to manufacture solar cells from UMGSi silicon, a lower grade of silicon that can be acquired more readily than polysilicon. This is an important advantage since there is not enough polysilicon available to meet current industry demand and polysilicon is a primary raw material used by most solar manufacturers. As of March 31, 2008, Photowatt France had annual ingot, wafer, cell and module production capacity of approximately 60 megawatts (“MW”).

Quantative Background Statistics (as of 3/31/2008 – All numbers in Canadian):

Share Price:

High Share: April 2006 about $18.00
Low Share Price: December 2007 at about $4

Shares Outstanding: 70.5 million

Current Share Price as of this report: $7.40 (Canadian)

Market Cap: $525 million

Cash: $57 million

Debt: $29 million

Envoy Research Note: The balance sheet could change dramatically over the coming year due to various divestitures as well as access to credit lines. Effective June 2008, a 17-month credit agreement was signed providing credit facilities of up to $85 million.

Enterprise Value: $500 million

2008 Sales: $664 million (ASG: $465 million and PhotoWatt: $199 million)

Envoy Note: ASG: Fiscal 2008 Order Bookings were $531 million, 20% higher than the previous year, driven primarily by strong Order Bookings in healthcare and energy sectors. Order Backlog of $232 million at March 31, 2008 was 25% higher than at March 31, 2007 primarily reflecting higher Order Bookings throughout fiscal 2008 compared to fiscal 2007.

2008 EBITDA By Segment:

ASG Fiscal 2008: Excluding severance costs fiscal 2008 EBITDA was $20.0 million (actual operating earnings were $12 million or 3% of sales), compared to EBITDA of $21.3 million in fiscal 2007

ASG Fiscal Fourth Quarter 2008: Excluding severance costs, fiscal 2008 fourth quarter EBITDA was approximately $7 million compared to $1 million EBITDA the year before.

Note: In 2005, which appeared to have been ASG’s best year in recent history, the company reported operating earnings of $38 million or about 7% of sales on revenue of $547 million. So in theory, assuming the company continued to reduce costs and improve profitability, ASG could achieve 7% operating margins, implying Operating Earnings of approximately $47 million and EBITDA potential of approximately $55 million.

PhotoWatt Fiscal 2008: Excluding certain one-time gains 2008 EBITDA was $6.0 million, compared to EBITDA of $29 million in fiscal 2007

PhotoWatt Fiscal Fourth Quarter 2008: fiscal 2008 fourth quarter EBITDA was approximately $7 million compared to $6 million EBITDA the year before.

Envoy Note: Lower profitability in fiscal 2008 primarily reflected the launch of UMGSi products. UMGSi products were sold at up to a 10% discount compared to polysilicon products, and produced lower cell efficiency resulting in fewer watts to sell at a given level of production. In addition, Photowatt France initially experienced high scrap rates and reduced throughput as it ramped UMGSi production. However, in the fourth quarter of fiscal 2008 UMGSi cell efficiency improved, selling price differentials decreased and throughput and scrap rates for UMGSi products achieved more acceptable levels. Overall it would appear that with despite lower operating profits from UMGSi modules, it would seem that with increased sales PhotoWatt absolute EBITDA dollar value could easily equal $30 million per year.

Capital Expenditures:

Cap-Ex 2008: $21 million – $4 million for ASG and $17 million for PhotoWatt

Envoy Note: What is clear from these cap-ex numbers is that despite the need for significant cap-ex at PhotoWatt to expand operations, ATA.TO’s ASG business can generate enough positive free cash-flow (EBITDA – Cap Ex) from operations to support that business, as well as the ASG business.

Summary Quantative Analysis/Valuation:

Overall the numbers, in a somewhat simplistic manner (which is all that is really needed for stock analysis) above seem indicate that the current valuation of ATS does not take into consideration the value of at least of its subsidiaries.

From one perspective, it would seem reasonable to price ASG at 10X potential EBITDA or about $550 million, implying that the current share price assigns zero value to the PhotoWatt business. From another angle, one can argue that PhotoWatt could be worth about 2X revenue (as many other solar suppliers are worth) or about $400 million, implying that ASG is valued at a mere 2X EBITDA.

In sum, my guess is that based on the operating potential here one could easily justify a price tag of $13 to $15 for ATS or about $800 to $1 billion in Enterprise Value (10X EBITDA for ASG and 2X Revenue for PhotoWatt, about 15X potential EBITDA of $30 million).

What Went Wrong and What Has Changed?

There was so much that was wrong at the old ATA and so many new changes are in the process of being implemented that it is difficult to addresses all of these issues in one post. More importantly, the company has already neatly outlined all of the past problems and current resolutions in its annual MD&A report. I, therefore, recommend that interested investors read at least the first five pages of this report for a quick summary of What Went Wrong at ATA.TO and What Has Changed. You can click here to download the MD&A report.

What Are the Major Risks To ATA.TO?

Will Some Solar Companies Face a Cash Crunch?

June 12th, 2008 by Yehuda Fruchter | No Comments

Introduction

This post is devoted to some thoughts on companies in the solar industry, particularly the Chinese polysilicon-based solar module manufacturers. The basic issue I address here is the risk for a serious cash crunch at some of these module manufacturers given their working capital deficits and their capital expenditure requirements.

Moreover, despite seemingly positive accounting earnings reports from many of these companies, a more careful perusal of these companies balance sheets raises serious questions as to the viability of their businesses, given the continued cash outflows. Importantly, this post does not address thin-film solar manufacturers, and my basic points do not apply to these businesses given the different economics of the thin-film segment of the solar panel industry.

Accounting Operating Metrics Are Misleading

Wall Street’s propensity to value Chinese solar companies off of accounting earnings, MW produced, and other non-cash metrics, completely obfuscates the significant cash-flow problems that many of these companies currently face. The cash-flow issues are caused by significant working capital needs, and it’s hard to imagine how the working capital situation can be improved any time soon, even in the event that polysilicon prices ease. There is simply too much competition in the industry and therefore suppliers, as well as customers, will continue to squeeze these companies on payment terms and cycles.
In the meantime, these companies are only able to keep their doors open due to a continued influx of cash in the form of loans, dilutive equity offerings, and other financial vehicles that Wall Street investment banks arrange. At issue, though, is how these companies would fare, should financing become more difficult. The businesses continue to burn thru so much cash, that it seems very likely that without financing many of these companies would go bankrupt very quickly.

Additionally, since few investors are paying attention to cash-flow, and most reports on these companies focus on accounting earnings and sales, there is a very strong incentive on the part of these companies to engage in questionable sales practices and revenue recognition policies (Note: The evidence for this is somewhat speculative, but is based on countless past examples, in other industries, of major working capital deficiencies signaling suspicious sales activity, such as “channel stuffing” and the like – see below for some interesting comments in SOLF’s 20-F filing).

The Evidence: Risk Statements in SEC Filings

Before getting to specific financial evidence, I’ll address a basic question: Why don’t these companies make money (cash, that is)?

Well, it’s quite simple. They have significant working capital deficiencies that are, and cannot be remedied any time soon, even in the event that polysilicon prices ease.

Here’s how speculative favorite Canadian Solar (CSIQ) explains the situation in the company’s latest 20-F (Note: CSIQ’s situation, is by no means unique, and is shared by nearly every polysilicon based module manufacturer. I have chosen to focus more specifically on CSIQ since it is a company I am more familiar with and additionally it is one of only a handful of companies that has already filed a complete 20-F):

“Advance payments to our polysilicon and silicon wafer suppliers and credit term sales offered to some of our customers expose us to the credit risks of such suppliers and customers and may increase our costs and expenses, which could in turn have a material adverse effect on our liquidity. Under existing supply contracts with many of our multi-year silicon wafer suppliers, and consistent with industry practice, we make advance payments to our suppliers prior to the scheduled delivery dates for silicon wafer supplies. In many such cases, the advance payments are made in the absence of receiving collateral for such payments. Moreover, we offer some of our customers short term and/or medium term credit sales based on our relationship with them and market conditions, also in the absence of receiving collateral. As a result, our claim for such payments or sales credit would rank as unsecured claims, which would expose us to the credit risks of our suppliers and/or customers in the event of their insolvency or bankruptcy. Accordingly, any of the above scenarios may have a material adverse effect on our financial condition, results of operations and liquidity.”

And this from Yingli (YGE):

” Historically, we required many of our customers to make an advance payment of a certain percentage of their orders, a business practice that helped us to manage our accounts receivable, prepay our suppliers and reduce the amount of funds that we needed to finance our working capital requirements. However, this practice of requiring our customers to make advance payments has diminished, which in turn has increased our need to obtain additional short-term borrowings to fund our current cash requirements. In 2007, a small portion of our revenue was derived from sales that required advance payments from our customers. Currently, a significant portion of our revenue is derived from credits sales to our customers, generally with payments due within two to five months. In addition, other customers now pay us through letters of credit, which typically take 30 to 90 days to process for us to be paid. As a result, the general decrease in the use of cash advance payments has negatively impacted our short-term liquidity and, coupled with increased sales to a small number of major customers, exposed us to additional and more concentrated credit risk since a significant portion of our outstanding accounts receivable is derived from sales to a limited number of customers.”

Another interesting quote, relating to the veracity of sales reported in earnings reports and collectiability of receivables, comes from SolarFun’s F-1 filing:

” With certain significant customers, we enter into framework agreements that set forth our customers’ purchase goals and the general conditions under which our sales are to be made. But such agreements are only binding to the extent a purchase order for a specific amount of our products is issued and certain sales terms may be adjusted from time to time. For example, we entered into a framework agreement with Social Capital S.L. under which it agreed to purchase 84 MW of PV modules in total from 2007 to 2008. However, since we could not reach an agreement with Social Capital S.L. on actual sales terms, Social Capital S.L. has not made any purchase order of our PV modules and it is unlikely that it will purchase our PV modules in the foreseeable future. In addition, we have in the past had disagreements with our customers relating to the volumes, delivery schedules and pricing terms contained in such framework contracts that have required us to renegotiate these contracts. However, renegotiation of our framework contracts may not always be in our best interests and disagreements on terms could escalate into formal disputes that could cause us to experience order cancellations or harm our reputation. “

The Evidence: The Financials

While CSIQ reported a huge earnings jump in Q1 2008 of $0.61 per share, the company, in fact, lost a significant amount of money and the earnings number is a complete mirage for significant cash-flow problems. If you compare the company’s balance sheet in Q1 to the balance sheet in the 20-F, the cash-flow issue is quite salient.

Specifically, as of 12/31/2007, CSIQ had approximately $38 million in cash, $59 million in receivables, and $71 million inventories. On the liability side, the company had $40 million in short-term borrowings, $8 million in payables, $75 million in convertibles, and $18 million in long-term debt.

On 3/31/2008, though, after a supposed record earnings quarter, CSIQ reported the following:
$32 million in cash, $119 million in receivables, and $81 million inventories. On the liability side, the company had $71 million in short-term borrowings, $17.5 million in payables, $75 million in convertibles, and $20 million in long-term debt.

Basically, in Q1, CSIQ had approximately a $60 million cash deficit (it’s difficult to get an exact number here since the company doesn’t release quarterly cash-flow statements) because of uncollected receivables. The company financed that huge loss via an additional $30 million or so in debt, and some non-strategic supplier loans (e.g. “accounts payable loans”). Even with all the financing, the company still managed to burn thru cash.

In case, this analysis sounds too shocking, perhaps it’s simpler to just point out that in CSIQ’s 20-F for fiscal year 2007, the company reported a mere $300K loss, or $0.01 per share, on an accounting basis. However, the cash-flow statement in the 20-F shows quite clearly that the company actually lost $80 million in 2007, due to accounts receivable issues and advance payments.

But, CSIQ is not alone. Industry heavyweight Suntech Power (STP) supposedly had earnings of $170 million, or $1 per share in 2007. However, actual cash-flow shows a slightly different story. In fact, STP lost $9 million in cash from operating activities in 2007.

And the list goes on: YingLi (YGE) lost over $300 million from operating activities in 2007, despite claiming a $52 million accounting earnings gain.

Conclusion

In conclusion, as is spelled out in the risk portions of polysilicon-based PV suppliers, and as is evident from annual and quarterly financials, working capital cash-flow deficiencies are a serious financial drain on many of these companies. As such, valuing these companies off of earnings is misleading and vastly overstates the underlying economic value of the companies.

Moreover, considering the tremendous amount of capital expenditures still needed by these companies to ramp up production to meet demand, it should be obvious that polysilicon-based suppliers are starving for cash. However, since the industry is currently oversupplied and suppliers have little differentiation, it seems clear that there is a significant risk that these companies could face a cash crunch should investors grow tired of financing these companies.

Finally, since these companies recognize that Wall Street rarely looks into actual cash-flow, they have every incentive to book unprofitable and questionable revenues, in an effort to produce strong top-line and accounting-earnings growth. Nevertheless, when certain contracts are called into question by customers, and other questionable revenue recognition policies are addressed, companies may need to restate earnings and erase past profits.

Disclosure: I hold no position, either long or short, in any of the stocks mentioned in this report.

Housing Hits Zilog (ZILG), But Future Growth Opportunities Abound

August 6th, 2007 by Yehuda Fruchter | No Comments

Currently there is alot of discussion about whether the current Wall Street credit crunch, will spread to the “real” economy. Generally, Wall Street’s paper economy is quite divorced from any reality, and hence major downturns in Markets do not cause significant ripples to other unrelated “real” sectors of the economy. However, the current sell-off may very well be an exception.

Case in point: Zilog (ZILG), a fabless semiconductor company, that at first glance would seem quite immune from happenings in the credit markets. Last week, however, the company reported a significant revenue decline both year-over-year and quarter-to-quarter. The reason given: a slowdown in housing.

As CEO, Darin Billerbeck, explained:

“The sales decline for the quarter was disappointing and reflected a generally soft demand overall. The North American home security market was slow due to the decline in new housing starts which impacted the end consumption of certain of our legacy products.”

The stock has taken a dive since the earnings report and has now fallen nearly 40% from its high reached back in June. Of course, the key question, now is what to do with ZILG after this decline? The answer, as always, is to stay positive and focus on the fundamentals. As we have stated in past posts, small cap stocks are simply getting mauled in the current market downturn. The key thing is recognize that the selling is primarily driven by overleveraged hedge funds and other panicky investors. The declines have little to do with the underlying financial health and potential of these companies.

In the case of ZILG, despite the sales decline, the company still managed to generate some cash during the quarter and ended the quarter with nearly $20 million in cash and no debt. Hence, the company has absolutely zero financial risk at this time, and therefore can be bought on dips.

Furthermore, the sales dissappointment was entirely related to the company’s legacy product line, which does not represent the future of the company. Importantly, the company’s newer embedded flash 8-bit products were up sequentially 19 percent and 52 percent year over year. In addition, the company is making excellent progress in bringing to market its 32-bit ARM based products for the secured transaction market. Both the Flash and ARM-based products represent substantial growth opportunties for ZILG over the next few years. Unfortunately, these newer product lines are still only a small portion of ZILG’s total revenue and hence their financial impact is not yet felt in the company as a whole.

However, we still remain confident that the company has the right management team in place, and the necessary financial strength, to generate significant revenue growth from the new Flash and ARM product lines in the coming years. As we’ve mentioned in the past, new CEO,Mr. Billerback was a former co-head of Intel’s $2 billion Flash division and we remain confident that he has the skill set and connections to greatly expand ZILG’s business in its new target markets.

Moreover, the valuation of the company does not in the least bit reflect the potential of these growth opportunities. At current prices, ZILG’s Enterprise Value is a miniscule $43 million, which when measured against our low-end base scenario of $60 million in annual revenue, implies an EV/Sales ratio of 0.7X. On a more normalized revenue run rate for ZILG of $80 million a year, this would translate into a ludicrous 0.5X EV/Sales. As such, we still expect that as the company’s Flash and ARM products ramp up in 2008, the stock’s valuation could jump significantly, as investors assign a more normalized valuation to the company in line with industry comps.

Please Note: We hold a position in ZILG. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

Can SGIC Be Revived?

April 11th, 2007 by Yehuda Fruchter | No Comments

A post-bankrupt company, with a strong brand, incomprensible financial statements, and no analyst coverage. What’s not to like?

The above succintly describes why we are bullish on Silicon Graphics (Nasdaq: SGIC), and we think you may want to take a closer look at the stock.

Business Background and Recent Changes

If you’ve followed technology long enough, we’re sure you’re familiar with Silicon Graphics, and so we’ll spare you all the details here. What you may not know is that SGIC emerged from a bankruptcy about six months ago, and is now valued, on an enterprise basis, at about $300 million. Quite a markdown from the days when the company was a tech darling and was fetching over $7 billion.

Of course, much has changed at SGIC over the years, and the company is now quite different than it once was. As such, we encourage you to read thru the links below to get a good understanding of the past problems and the current revival:
http://www.hpcwire.com/hpc/655167.html

http://www.businessreviewonline.com/blog/archives/2006/07/will_sgi_become.html

http://www.computerworld.com/action/article.do?command=viewArticleBasic&articleId=9000369

Finally, just two days ago the company announced that it hired Robert Ewald as the new CEO. For a good appreciation of Mr. Ewald, we provide you with this link:

http://www.taborcommunications.com/hpcwire/features/people05/

Quick quote from the article above:

“In basic terms, we keep an eye on Bo because we’ve been watching him for so long; he’s an industry legend. As a user, he was one of the original Cray-ons — way back in the 1970s — and he’s been a key mover at both Cray Research Inc. and SGI. Aside from being a motivational leader, Bo brings a wealth of insider knowledge to up-and-coming LN. “

“Bo’s leadership skills and extensive experience in a range of high-performance computing and storage markets make him the right CEO to lead SGI to success, not only in the traditional technical and scientific HPC market, but also in new enterprise HPC segments where SGI’s technologies have significant potential.”

Low Downside Risk
As is the case with all our tech stock picks, we like SGIC because the company’s stock price is at historically depressed levels, and yet the company is undergoing some significant and positive changes. From our perspective, the downside appears very limited at current prices, while the upside potential could be substantial, i.e. 100%+, over the next year or two.

Briefly, your downside is protected by:

Strong Balance Sheet. The company’s financial condition is currently solid, with the company sporting a net cash position for the first time in many years.

Large and Recurring Base Business. The company has a large customer base (see articles above) that generates a substantial service revenue stream of over $200 million. The revenue stream is, in theory, a cash-cow, especially in the hands of a potential competitor or private equity shop, who would not need to use the cash coming in for growth investments.

Strong Brand. Despite the bankruptcy, SGIC’s brand remains strong in the tech community.

Low Valuation. The company’s valuation is quite low, with an Enterprise Value to Sales ratio, well beneath 1, and a normalized EV/EBITDA ratio of about 5, in our estimation. In other words, the stock price already reflects alot of pessimism or should we say skepticism about a true revival at SGIC.
M&A Potential. Depending how you look at it, M&A potential either protects your downside or provides the upside. In the case of SGIC, we think the company will prove valuable to many companies, especially if SGIC is able to start penetrating the enterprise market. Furthermore, the company could be cheaper to acquire than fight in court (see below about patent lawsuits).

Upside and Hype Potential

Because the SGI story has been rehashed so many times, it’s difficult, at first, to see what Wall Street can potentially use this time around to sell the SGIC story to investors. However, we’ve come up with a few positives.

New Sustainable Growth. Hidden from most investors is that under a completely new management team, SGIC’s backlog is finally growing again, the business has turned cash-flow positive, and several new products will be introduced in the coming year that could have an ongoing positive impact on the top and bottom line. A couple of clean quarters of growth and some traction with new products, should get a few funds excited about this name again. It’s important to remember that given SGIC’s large customer base, the potential for successfully upselling new solutions in quite large. It shouldn’t require more than a good product and of course excellent marketing.

Patent Profits. In addition, as a former tech leader, SGIC has an extremely strong patent portfolio and potential settlements+royalties on these patents could send the stock soaring. One notable patent lawsuit can be read about here. Interestingly, Nvidia supposedly licensed this same patent for over $50 million+ over 8 years ago, when NVDA was a relatively small company and the graphics card industry was still developing. The implication is that this patent is substantially more valuable today given the growth in the industry since the original NVDA license. Besides, this one there are other far-reaching patents that SGIC is supposedly looking to license.

Analyst Coverage. No analysts cover the company yet. However, we expect that once SGIC’s financials become a bit more comprehensible (i.e. there are still alot of accounting adjustments in the financials due to the recent emergence from bankruptcy) later this year and next, that Wall Street will begin covering the company again. With the increased exposure given by Wall Street research, the stock should rise.In fact, our research indicates that the company could be worth between $60 to $90 based on comp. multiples.

Back-of-the-Envelope Valuation

A valuation of SGIC is extremely difficult because the financials are somewhat incomprehensible due to GAAP Fresh Start accounting, and it’s next to impossible to value the company’s intangible assets, such as patents.

However, if you use management’s “adjusted” numbers, you get $536 million in Revenue for 2007, which pretty much matches the $550 million the company was projecting in its bankruptcy report. The problem, though, is that some of that revenue is from legacy business, which are next to worthless.

In any case, revenue multiples in the industry are from 1X to 1.5x, which seems fair and, in truth, the entire industry seems quite cheap when compared to other areas in tech. EV/EBITDA ratios for SGIC’s comps. are in 10X to 12X range.

SGIC has about 11 million shares out, so we have about a $330 million market cap. Taking out net cash, gives a $300 million value for an EV/Sales of 0.57, which is clearly cheap given the recurring nature of a large portion of revenues in combination with the gross margin situation. SGIC’s internal forecasts call for 2008 revenue of $600 million, implying a forward EV/Sales ratio of 0.5X. Upside at 1X sales is therefore $55 to $60, or about a double.

Valuing the company on the EBITDA front is a bit trickier, since the company’s EBITDA margins are currently quite depressed for a wide variety of reasons. For instance, the company’s internal estimates given during bankrupty proceedings call for called for EBITDA of $40 million next year, which implies a price of $40 to $45. But it’s possible that the EBITDA figures here are way off. EMC has nearly 20% EBITDA margins and others are at 8% to 10%. So it seems possible to do 10% EBITDA margins here, for EBITDA of $55 to $60 million, which again implies a stock price of $55 to $60.

Additional Considerations and Risks

Strong Government Focus

As the company states:

“A significant portion of our revenue is derived from sales to the U.S. government, either directly by us or through system integrators and other resellers. Sales to the government present risks in addition to those involved in sales to commercial customers, including potential disruptions due to changes in appropriation and spending patterns. Our U.S. government business is also highly sensitive to changes in the U.S. government’s national and international priorities and budgeting”.

Declining Legacy Business

As the company states:

“Future revenue growth from our newer product families is especially important because revenues from our traditional MIPS and IRIX products and maintenance business are expected to continue to decline. Our ability to achieve future revenue growth will depend significantly on the market success of these newer product families in servers and storage as well as our ability to generate sales to match or replace revenues generated from large sales transactions in prior periods. If one or more of the product lines were to fail in the market, it could have an adverse effect on our business and liquidity. “

Disclaimer:

We own shares in SGIC. This site may include market analysis and we may own shares in the stocks mentioned in our reports. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

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Summary: Why Is ATS Automation (ATA.TO) a Potentially Attractive Speculation

Company Background

Quantative Background Statistics (as of 3/31/2008 – All numbers in Canadian):

Summary Quantative Analysis/Valuation:

What Went Wrong and What Has Changed?

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