MTI Wireless Edge - Assets Underpin A Higher Valuation

http://www.mtiwe.com/


The site's portfolio is now very close to full capacity with 17 open positions - I consider 20 open positions to be the limit at any one point in time. Following on from the last article, this review takes a look at another micro-cap company, one that I find a far better investment proposition. That company is MTI Wireless Edge (LSE:MWE). Once again, the size of the company (currently £4.13m) means that any investment is inherently high risk, but on this occasion I reckon the risk/reward ratio is pretty good. MTI Wireless (abbreviated at MWE from now on) operates within the Technology Hardware & Equipment sector of the LSE, and despite suffering from a slow rebound since 2009, is showing clear signs of improvement. Following an upbeat news release in recent weeks, MWE is trading at 8p/share with a total of 51.57m shares in issue.


The technical position of MWE is definitely improving. There have been many instances (including AEO and ESS) when I have been impressed by the company fundamentals, but have been put off by the lack of liquidity. It's safe to say that these have led to the site missing out on huge potential gains. Therefore, I am happy to dismiss those concerns on this occasion. Despite being illiquid, the recent increase in volumes means that the spread is acceptable. It is circa 8.10/8.17 to buy (depending upon the volume) which is not unreasonable. However, that price has been slipping over the last few days (from 8.30) which suggests there is a seller in the background. That has prevented subsequent rises after the recent move up to 8p. I'd imagine that once that seller is cleared, the price could push up further.

The company shareholding structure is a little odd. Two of MWE's directors (Zvi and Moshe Borovitz) hold 50% of MWE's holding company, MTI Computers. MTI Computers holds a 52.4% stake in MWE. That does mean that only 31.4% of shares are held by the public. Directors hold 7.4% of shares and employees hold a further 3.2%. Herald Investment Management is the only institution holding a notifiable interest, with a stake of 5.4%. Herald could be the seller as they purchased the shares many years ago for a total cost of £504,000. However, there are likely to be several private investors who are willing to sell out on any upward moves, causing natural resistance.

Holding company MTI Computers is actually listed itself, although on the Tel-Aviv exchange. Their share price has started to turn upward having been in years of decline. MTI traded around 700ILs in 2009 but fell to circa 135ILs in the aftermath of the financial crisis. Over the past year the share price has risen to 182.2ILs from around 140ILs. MWE is one of MTI's core holdings and is unlikely to get sold down considering that Moshe Borovitz is the CFO of MTI Computers.

There is another link between MWE and MTI to be aware of. 2 MWE directors hold a 25% share in Mokirei Aya which is the owner of MTI. A few years back, MWE purchased a building (which they were using 3 quarters of) from MTI for $5.2m. That deal reduced MWE's operating costs by $300,000 per year, plus the 25% of office space not used was rented back to MTI. MTI itself is not in a particularly great financial position as its other subsidiaries are struggling a little. MTI therefore took out a $1m bank loan recently, and asked MWE to provide a guarantee in exchange for a 2.5% yearly compensation fee. That went ahead, but there was an amendment prior to completion. The amendment effectively meant that, if MTI can't pay back the $1m, MWE will pay a special dividend to cover the charge, to all shareholders. That means all shareholders would be able to partially cash in, should MTI encounter financial difficulties. The downside is that the normal dividend may be kept conservative as a precaution, but I don't consider that an issue. Regardless, that is a nice backstop to have.

One of MWE's Omni
Directional Naval Antennas
I feel obliged to mention the usual caveats of investing in such situations. Firstly you have the risk (albeit low in my opinion) of MWE delisting. As with any micro-cap the AIM listing costs can form a significant amount of the company's administrative expenses, and on some occasions companies delist as part of a cost-cutting exercise. However, as I will get on to later, MWE is profitable, so this risk is lower. The second point is that MWE is illiquid so the bid-ask spread can widen if interest falls. That can make it difficult to sell at an acceptable price. Finally, you can ask the question: "Has the company done enough to help the share price over the last few years?"

MWE describes itself as a 'One stop shop for your antenna needs'. The company was established in 1972 and is the designer, manufacturer and supplier of antennas to both the military and commercial markets. The company is incorporated and based in Israel, which has a large defence export sector. There are three main types of antenna (ranging from 2MHz to 90GHz) that it sells to its international customer base:

- Broadband Wireless (E.g. for WiFi)
- Radio Frequency Identification [RFID] (E.g. for Near field and handheld readers)
- Military (Ground, naval and airborne antennas)

The company has been operating an Indian manufacturing facility since 2009 in order to cut costs. That contributed around 30% of the total group production in 2012. The remainder of the antennas have their basic components made predominantly by subcontracted firms - these components include the mechanics, plastics and printed circuit boards. These are then returned to MWE's Israeli headquarters where they are tested and verified. In 2012, 84% of the revenues were from the commercial market with the remaining 16% from military. That balance is changing towards a greater military weighting and within the commercial market, investment into the 60-80GHz antenna range has led to a tripling of revenues in recent years.

In terms of competition, most rivals are of a similar size to MWE. However, there are some major competitors such as Laird, European Antennas, PCTel and Mars Antennas (& RF Systems), which is also an Israeli company. Whilst the company does have several patents across different regions, there has to be an ongoing focus on R&D and that represents a material proportion of costs. The nature of the business also means that there is not great visibility - in 2012, 81% of revenues were from product sales with 19% from projects. Within the commercial market, most revenues are not related to long-term contracts, which means that MWE generally only has visibility of 2-3 quarters ahead. However, improving economic conditions have meant that a stronger order backlog is being seen, and that is helping financial visibility. 53% of revenues are derived from within Israel, 20% from North America, 16% from Europe, 8% from Asia and the remainder from other countries.

CEO Dov Feiner has commented that, "The underlying drivers of our business, such as continued growth in data usage and increasing subscriber numbers, are part of long-term trends which we expect to continue for the foreseeable future."

* (The real figure was lower due to the impact of one-off litigation costs.
That case has now been concluded so there will be no further costs
The record of the company over the past four FY sets of results (right) is clearly unexciting. Revenues have been trending downwards, gross profits have been steady, and net profits have been erratic, as have the cash flow readings. The 2012 year ended in a $193,000 loss once accounting for exceptional litigation costs and a tax benefit.

There is some risk in the form of revenue composition. In 2012, 2 commercial partners accounted for 33% of sales. However, the rest of the customers account for less than 10% of the total revenues, and further large contract wins since 2012 suggest that the risk it not particularly prominent.

Looking back at a set of pre-crisis results (2007), there are some interesting numbers that can be used for reference. With a very similar number of shares in issue, in 2007, MWE booked revenues of $19m, profit before tax of $4m, net cash generation of $2.6m, and a dividend of 1.85 cents (1.13p). Those figures read very well. The company has also proven that it does care about shareholders - in 2012 a dividend of 4.4% currently. It would have been higher at the time) was issued at a total cost of $299,000 - MWE have stated that they believe that 'shareholders should receive an annual yield' on their investment. In addition, pre-crisis the company embarked upon a share buyback scheme.

The most interesting part of MWE is definitely there 2013 and 2014 news flow to date. One major benefit is instead of issuing standard trading updates, MWE announces full financial statements for Q1 and Q3. That is good for keeping investors informed as the year progresses, and prevents guessing of the figures between reporting periods.

The positive news flow started in March 2013, when the company announced that it had won a major $1.45m military contract and an additional $0.55m in commercial orders. The order book was also up to $7.5m at the upper range. The 2013 Q1 results were then released in May, and this showed a return to profitability, revenues up at $3.4m and a net profit of $26,000 vs a $246k loss in the period before. The Q2 results confirmed the positive trend by showing an operating profit of $130k on the back of increased activity in military demand - the sector now contributes towards 20% of MWE's revenues.

Fast-forward and the most recent set of figures are the Q3 results. These showed the following (Figures converted from USD to GBP at the current exchange rate):
- 5% Y.O.Y revenue growth to £6.09m
- Gross margin up at 37%
- Strong military performance (9 month revenues > 2012 FY revenues)
- EBITDA of £330k
- Net office value of £2.07m
- Net income of £121k (although the finance expense of paying down the bank loan was offset by tax benefits. As the loan is paid back, this expense will fall, but equally the tax benefit is not indefinite)
- £4.048m in cash and other short-term financial assets
- Net receivables of £2.40m. These have been high for a long period of time so I would not expect this to be fully paid back
- Inventories of £1.77m
- Bank credit of £150k available with bank loans drawn down amounting to circa £1m. This bank debt figure was down by £114k over the period

One of MWE's airborne antennas
The raw financials definitely show an improvement over preceding periods. MWE is now profitable, and should continue to be in light of an improving economic climate, and a strong order book. However, the financial performance itself remains fairly immaterial (as it stands) as the profits are wafer thin when accounting for the tax benefit and finance expenses. This should improve, but that is not a massive pull for investors. The pull is that Current Assets (the tangible cash or equivalents) - Total Liabilities = £6.315m. That is versus MWE's market cap of £4.13m, and that means that MWE is trading at roughly 2/3rds of its intrinsic current asset value. You can argue that the trade receivables are not going to be fully recoverable, but even if you factor that out, the value of the property can take its place (the property value is not included in the current assets). Considering that the company is recovering, there seems to be a clear case that MWE will gravitate back towards its asset value, and then back to a fairer rating above that.

CEO Dov Feiner said: "Our gross margins improved due mainly to a strong performance in the military sector. As we anticipated, the 80GHz sector continues to developed and this year we have added a number of new customers to our growing list which we believe will contribute to future revenues and profits. With 5% Y.O.Y growth, a strong backlog of orders, and a healthy list of news customers, the board believes that [MWE] will continue to grow"

The Q3 results are primarily what attracted me to look at MWE. The recent January RNS confirmed my initial thoughts. It outlined that MWE had received a $1m order from a major commercial customer, and also that the full-year revenues would be slightly ahead of market estimates (which were circa $13m).

Dov Feiner, MTI's Chief Executive, commented: 'We continue to make good progress on all fronts and our order pipeline for 2014 - and into 2015 - is looking strong. The outlook for the Group remains positive and it is very exciting to be delivering revenues for 2013 which are slightly ahead of expectations.'

I believe that the above is enough for MWE to merit a Buy tag on the review list. The company arguably has not done enough to fuel a recovery over the past couple of years, but the underlying economic trends should, and are driving that recovery anyway. The issue of the dividend in 2012 is an encouraging sign, and there is a potential return of cash should MTI Computers require it. Aside from that, the company is trading at a large discount to its net current assets, which is especially rare in the current bull market. That is partly down to the liquidity position and a lack of market interest, to date. The sounds coming out of MWE are of increased confidence, and that could help propel the financials back to figures closer to those of 2007. If the trend is maintained, the shares could start to look exceedingly good value. The bottom line is that cash + inventories + office value - debt = £6.89m and that is far in excess of the current market capitalisation. Even applying a discount of 25% retrieves a figure amounting to £5.16m which is circa 25% above the current market cap. The business is therefore effectively thrown in on top. For a micro-cap company, MWE ticks all the sort of boxes that give it an excellent risk/reward ratio in my view. Certainly not one to form the entirety of a portfolio, but as part of a portfolio, it seems a sensible speculative choice. I have put a Buy tag on MTI Wireless Edge at 8.00p.

UPDATE (15/04/14) - The discount to the net assets has now been removed, as the company has rallied strongly from 8p through to 13.63p currently. It therefore makes sense to move MTI Wireless Edge to a No Rating tag, seeing as there is no upcoming news. I have therefore banked a 70.4% profit

4 comments:

  1. Excellent find el1te. Looks like an undervalued play!

    solooiler

    ReplyDelete
  2. I noticed last week that Pilat Global Media (LON:PIL) had a takeover offer at a 25% premium or so. That is another Israeli company. SimiGon [not sure if you've heard of them, but they sell flight simulation systems] has been on a good run, They are also Israeli.

    CraigJ

    ReplyDelete
    Replies
    1. I held shares in Pilat prior to the takeover bid. Very happy

      Delete
  3. Great find and write up, El1te

    ReplyDelete