Frank Voisin writes about value investing topics at http://www.frankvoisin.com
Relying On Old-Fashioned Stock Picking, Lee Ainslie Reports His “Strongest Quarter” Ever
Lee Ainslie's Maverick Fund USA enjoyed its "strongest quarter in the fund's history" during the three months to the end of June. According to a copy of the firm's second-quarter letter to investors, which ValueWalk has been able to review, Maverick Fund USA gained 18% in the second quarter. Following this performance, the fund was Read More
ClearOne Communications, Inc.(NASDAQ: CLRO) is a provider of conferencing and digital signage solutions. In the professional audio conferencing market, the company has an approximately 50% market share and has been a leading developer of new technologies used to enhance audio/visual quality. CLRO trades for about $42 million, yet it has $12.1 million in cash on hand (for those following along at home, you have to reduce the recent balance sheet data by $4.6 million to account for an acquisition subsequent to the end of the quarter) and no debt, bringing its EV to $29.9 million. Over the last two years, the company has generated an average of $4 million in free cash flow for a yield of 13.4% and over the last five years, the company has reduced its share count by 25.2%, though these repurchases were concentrated at the beginning of that period.
Its high and stable market share, strong gross margins (close to 60%) and high CROIC (the company has maintained a consistently high cash balance and no debt so Invested Capital is the best metric) lead me to believe the company has a moat. It is also encouraging to see that the company’s intellectual property is so attractive that others have attempted to steal it several times (with the company winning legal cases and damages in response).
Insiders own a significant percentage of the company, though this is somewhat masked. The company reports that, as of March 23, 2012, insiders own 13.8%, but this ignores the fact that Edward Dallin Bagley, ostensibly an outsider according to this document, owns 24%. Bagley is the father of E. Bryan Bagley, a director of the company. Though the two have disclaimed beneficial ownership of stock owned by the other, I think a more realistic scenario is that the son takes into consideration his father’s interests when serving as a director, so I would put inside ownership at 37.8%. I should also note that E.D. Bagley has been consistently purchasingthroughout April.
Initially I was worried that this small company was competing in the same field as Cisco Systems, Inc. (NASDAQ: CSCO), Avaya and Microsoft Corporation (NASDAQ: MSFT)’s skype. Instead, it appears that the company’s product line is designed to be used with these companies’ applications, so rather than acting as a substitute we should consider these complementary. Looking through the company’s list of competitors, it appears that a number say “(now part of… )” after their names, hinting that there has been some consolidation in this industry. Given its low EV, strong FCFs and large market share, it seems like it would be a good acquisition target. A logical purchaser would be CLRO’s largest competitor, Polycom Inc (NASDAQ: PLCM), which certainly has the financial capabilities to make it happen. My guess is that this hasn’t happened due to the large insider ownership.
Another thing I like about CLRO is that its manufacturing is completely outsourced. In this case, Flextronics International Ltd. (NASDAQ: FLEX) services the bulk of its manufacturing needs. This type of arrangement allows CLRO to focus on R&D and marketing, and leads to a more variable cost basis than if it had in-house manufacturing. The consequence is that CLRO remained profitable throughout the recession.
There are some worries about the company. One, which occurs whenever we see a company with a massive cash balance, is that the company will squander its cash on an acquisition binge. Indeed, the company has made several small purchases in recent years (NetStreams, Magic Box and VCON). In 2011, the company purchased MagicBox for approximately 11.3x earnings, which seems pretty conservative to me (In the recent 10-K, there is a section called “Supplemental Pro Forma Information” which you can use to back this information out). Another reason I am not as worried about CLRO squandering its cash hoard on acquisitions is that management stated at the end of the recent earning call that they do not plan to do any more acquisitions in the near term and are focused on integrating and leveraging their recent acquisitions.
Another worry is customer concentration. The company derives around 30% of its revenues in any given year from two distributors. This isn’t as high as we’ve seen elsewhere on this site, but it is still a risk and very difficult to mitigate from an investment standpoint.
One more risk worth noting relates to dilution. The company has options to acquire 1.2 million shares at a weighted average exercise price very close to the current price. This would increase shares outstanding by 13.2%. Between 30-40% of these options have strike prices that are well above the current share price.
I should note one more thing which you can weigh however you’d like. Two of the company’s former executives were imprisoned for falsifying the company’s financial records in 2001 and 2002 (around the time of the company’s merger with E.mergent). The company paid for their legal bills ($3+ million!), but is now attempting to have this money returned. This led to a class action lawsuit against the company which ultimately cost $5 million in cash and 1.2 million shares (see here). The company seems to have put this behind it and I see no reason to suspect ongoing problems.
So where does this leave us? If you can get comfortable with the customer concentration and the company’s worrisome past, CLRO appears to be a good opportunity.
What do you think of CLRO?
Author Disclosure: Long CSCO. May initiate a position in CLRO in the next 72 hours.