Good morning,
I would just like to share a long position which I added to my portfolio this week. It concerns Solitron Devices.
Solitron Devices is a manufacturer of Semiconductors for military, extraorbital and industrial purposes. It produces analog vs digital semiconductors (I dont quite know the difference, I lack a BA in engineering).
The reason I bought this stock is because it is trading at a 30% discount to NCAV. I believe the assets in place are of high quality. Its current market cap is 4,97 million. After subtracting all liabilities it has (roughly) 3,5 million in net cash. The remainder of the assets is tied up in 1 million of acc. rec (very high acc rev turnover) and 2,71 mio of inventory. The inventory consists mostly of raw materials and of goods already ordered by customers. It does not produce products that the customer has not ordered, therefore inventory can and should be liquidated at near 100% of nominal value. Furthermore it has an inventory reserve of nearly 1,4 mio which might or might not be too conservative.
The company is tiny, but it has been profitable for the last decade. Based on last years earnings the firm is yielding 16%. The reason for this high earnings yield is because it has a large tax loss carryforward worth 8 million. This tax loss carry forward is due to the bankruptcy of the firm in 1993, and lasts until 2023. With net income of 900,000 last year, and a tax rate of 30%, it will not be able to use the tax loss carryforward completely. This is one reason why the tax loss carryforward is only listed in the footnotes and not on the balance sheet. One can be safe to assume that the firm will not be required to pay taxes for the foreseeable future. This is an offbalance sheet asset that can definitely add value to the current shareholder.
I do not expect a massive increase in earnings but there are a couple of factors which could act as a catalyst to the firm:
1. The large tax loss carryforward. By buying this firm, a larger competitor could use this tax loss carryforward to lower incometaxes for the entire firm. This would unlock the value of this hidden asset. A cautionary note: The annual report states that a new majority owner of the firm might not be able to use all of the tax loss carryfowards.
2. A wrapping up of all bankruptcy proceedings. The firm has promised all previous creditors that it will not pay any dividends until all the bankruptcy obligations have been paid. As far as I can deduct, the firm is still obliged to pay 1.1 mio in accrued liabilities. At the current scheduled payment rate the firm will be done paying in 4 years. After this, the built up cash reserve could be used to redistribute to shareholders.
3. An increase in business due to the new ISO certification. The company recently received an ISO certification allowing it to produce semiconducters suitable for space. What the impact on the business will be, I have no clue, but it might be positive.
4. An increase in margins. Recently a large competitor left the market, motorola. A decrease in competition lifts the bargaining power of the firm and could increase margin. It could also increase its market share.
Risks:
1. The backlog has decreased over the last 12 months. This could imply a sharp decrease in demand and lower sales volume/margins. The company has relatively few fixed assets in place, thus the risk of a decrease in NAV is minimal.
2. Fraud. Altough I have no reason to suspect fraud (the firms accounting is pretty simple), the majority shareholders could be misrepresenting the figures.
3. Majority shareholders abusing their voting rights. Majority shareholders could abuse their position to siphon of shareholder value and take Something Off the Top (SOTT). There are some options outstanding but they have not increased significantly.
4. I dont understand the business. I have no idea how a semiconductor is made or what function it has. I could be buying into a dying company and/or industry and not know about it.
Conclusion:
The high quality of assets in place, the consistent earnings and the large tax loss carryforward make this a confident invesment. Something could happen that I have not foreseen in my analysis, but this is always a risk. I am just going to leave this stock for the next 2 years and see what happens. As pabrai says "Low Risk, High Uncertainty".
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