EF Johnson (EFJI) designs and markets wireless communication devices. Even before the economic storm, the company had been losing money, as it has reported negative operating income in each of the last three years. As a result of these losses, the company's market value has fallen tremendously: the company trades for just $20 million, while its net current assets (current assets minus total liabilities) are almost $40 million.
In the past, we have discussed why not every company that trades at a discount
to its net current assets warrants an investment. After all, if a company is burning through its assets (i.e. losing money), then the net current asset value is a moving target...downward. But in the case of EFJI, it may have been able to turn things around. The company managed to turn a profit in its latest quarter, and has dramatically reduced expenses while at the same time maintaining strong levels of R&D.
But the fact that the company may be profitable in the future is not enough. After all, the benefits of being able to buy a company at a discount to its liquid assets are only as good as the liquid assets themselves. In the case of EFJI, inventory is by far the largest single component of its current assets, making up $34 million dollars of its $40 million in net current assets.
For companies in slow-changing industries (e.g. for a net-net that sells screws
, bolts and other standard supplies), the inventory level can be more readily trusted. For companies in high-tech fields, however, the value of the inventory is much more in question. In the case of EFJI, management has already reduced its inventory value by $4 million due to obsolescence. With order backlog levels far lower than they have been in years, the risk of that inventory becoming even more obsolete increases further.
For some investors, the products this company makes may fall within their circle of competence such that they can estimate the value of this company's inventory with some level of certainty. For the rest of us, however, it is better to focus on companies for which we can estimate their values with more confidence. In this way, we know that we are getting a good deal.