A $90M Stock With Lots of NOLs, tax credit carryforwards, Cash Etc Which Could Easily Double

Excerpt from the Stanphyl Capital letter to investors for the month of April 2018  discussing their long positions in two micro-cap plays. Stanphyl was profiled in the second edition of HVS and has had some of the best picks among all the funds we have profiled with 200%+ returns on some pitches.

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We continue to own XXXXXXXXXXXX, a designer and manufacturer of  XXXXXXXXXX companies, which in February reported a Q4 2017 roughly in-line with previous guidance. Following extensive restructuring, XXXX is now a GAAP profitable company with around $X50 million of annual 3X% gross margin revenue, $X million in free cash flow, $3X million of net cash and approximately $34X million of U.S. NOLs, $1X million of U.S. tax credit carryforwards, $23X million in foreign NOLs and $4 million of foreign tax credit carryforwards. Assuming 5.X million shares outstanding and valuing the company at just X0% of revenue on a EV basis plus adding in just $3X million for all the NOLs and tax credits makes this a mid-$X0s stock vs. our basis in the $15s. The company has an ongoing process to investigate “strategic alternatives” and may sell itself, buy something that can utilize the NOLs or return some cash to shareholders, or it could decide to simply follow its current course of gradual improvement. I’m comfortable owning it at our price basis in any of those circumstances.

We continue to own Aviat Networks, Inc. (ticker: AVNW), a designer and manufacturer of point-to-poi nt  microwave systems for telecom companies, which in February reported a Q4 2017 roughly in-linewith previous guidance. Following extensive restructuring, Aviat is now a GAAP profitable company witharound $250 million of annual 32% gross m argi n revenue, $6 million in free cash flow, $33 million of netcash and approximately $340 million of U.S. NOLs, $16 million of U .S. tax credit carryforwards, $232million  in foreign NOLs and $4 million of foreign tax credit carryforwards. Assuming 5.4 million sharesoutstanding and valuing the company at just 50% of revenue on a EV basis plus adding in just $30 millionfor all the NOLs and tax credits makes this a mid-$30s stock vs.   our basis in the $15s. The company hasan ongoing process to investigate  “strategic alternatives” and may sell itself, buy somethin g that canutilize the NOLs or return some cash to shareholders, or it could decide to simply follow its currentcourse of gradual improvement. I’m comfortable owning it at our price basis in any of thosecircumstances.

We continue to own Echelon Corp. (ticker: ELON), a perpetually disappointing “industrial internet of things” networking company with approximately $32 million of annual 53% gross margin revenue and an enterprise value of less than $2 million. In February Echelon reported Q4 2017 revenue of $8 million (up slightly vs. Q3’s $7.8 million) and guided to a roughly flat Q1 2018, with operating cash burn disappointingly continuing at a bit over $1 million per quarter. Echelon is now focusing its growth on “smart” commercial & municipal LED lighting (although its fab-less chip business has apparently now stabilized after a long decline), and if the lighting business accelerates (and it could, due to recent sales force hires and new products), I think there’s a chance it can hit a break-even annualized revenue run-rate of $40 million by Q4-2019 (pushed back from my earlier hoped-for timeline) at which point—assuming $14 million of remaining net cash (vs. an estimated $18 million at the end of Q2 2018) and 4.7 million shares outstanding (vs 4.52 million today), an enterprise value of 1x revenue on this 53% gross margin company would put the stock in the mid-$11s per share. Additionally, Echelon has approximately $255 million in federal NOLs and $127 million in state NOLs, worth tens of millions of dollars if it can utilize them. So if it can pull this off (and theoretically, the market for the networking of commercial and municipal LED lighting should be huge between the U.S. and Europe), this stock could be a home run for us. So far though (as noted above) there seems to be little sign of improvement, and although the stock is now near all-time lows I won’t add to the position unless the current CEO (who has had more than enough time to fix things) is replaced.

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