National Technical Systems - Investors Have Landed The Sweet Spot

Aug.20.13 | About: National Technical (NTSC)

Investors in National Technical Systems (NASDAQ:NTSC) already had a great run, but received icing on the cake after the company agreed to sell itself to private equity firm Aurora Capital Group.

Investors who have done their research into this small-capitalization firm have seen great returns this year, nearly tripling their investment. On a stand-alone basis, NTS could not warrant the current valuation, as such investors are best advised to tender their shares to Aurora.

The Deal

National Technical Systems announced that it has entered into an agreement to sell itself to affiliates of Aurora Capital Group.

The deal which will take the company in private hands, values common outstanding stock at $23.00 per share, or an almost 39% premium compared to Thursday's closing price. As such the deal is valued around $265 million, or around $305 million including the assumption of debt.

The deal is subject to shareholder approval by shareholders of NTS. A special meeting during which shareholders can vote on the proposed transaction will be held before October 31 of this year.

A special committee, formed by three independent directors, have considered the transaction and negotiated the offer. The special committee and the board of directors shave given unanimous approval in favor of the deal.

The deal is subject to normal closing conditions, and if all goes to plan should be closed before the end of the year.

Valuation

National Technical Systems ended its first quarter of its fiscal year of 2014 with $11.4 million in cash and equivalents. The company operates with $50.3 million in total debt, for a net debt position of around $39 million.

Full year revenues for the fiscal year of 2013 came in at $184.5 million, up 18.8% on the year before. Net income came in at $4.4 million compared to a mere $0.5 million a year earlier.

The $265 million valuation for the equity of the business values operating assets of the firm at 1.4 times annual revenues and around 60 times annual earnings.

National Technical Systems does not currently pay any dividends to its shareholders.

Some Historical Perspective

Long term holders in National Technical Systems have had a great run in recent years. Over the past decade the small capitalization firm has been a dormant stock trading anywhere between $4 and $8 per share.

Shares started the year of 2013 around $8 per share, and just eight months later investors stand to receive $23 for their shares, as shares have nearly tripled so far this year.

Between the calendar year of 2009 and 2012, National Technical Systems has increased its annual revenues by a cumulative 50% towards $185 million. Net income increase by a third to $4.4 million.

A Hint For The SEC?

Researching the events upto the merger agreement reveals an interesting fact. Shares have steadily risen from $8 in January to levels around $14 in June.

But then things get interesting. On the 28th of June trading volume for the day totaled some 767,000 shares, or almost 7% of the total shares outstanding. While shares hardly moved on that day they rose some 7% on the day following. Note the average turnover over the past trading month only total 78,000 shares a day, and this calculation includes the 1.02 million turnover on Friday.

Investment Thesis

The proposed deal gives shareholders in National Technical Systems a great opportunity to monetize their investment.

Deals like these, in addition to the great run-up in the shares so far this year, once more illustrates that there is value to be found in the small capitalization section of the stock market.

National Technical Systems' core management team and staff remain to work independently, while NTS adds to Aurora's expertise in aerospace, defense and transportation.

The recent run up in the share price, even before the offer from Aurora, was driven by an improvement in operating performance. First quarter net earnings rose from just below the $1 million mark to $1.4 million, driven by gross margin expansion. NTS took $0.3 million in restructuring charges over the past quarter to boost annual cost savings by $5 to $6 million.

At this rate, net earnings could approach $10 million going forwards, still valuing the business and the deal at 26-27 times annual earnings. On a stand-alone basis, shares could never warrant the current valuation, as the valuation is quite expensive, especially for a small-capitalization firm.

Given the current valuation, especially the premium price-earnings multiple being paid for NTS, shareholders are in the sweet spot. As such they should have no problems tendering their holdings at these premium valuation levels, after receiving a generous 39% premium for their holdings.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.