George Risk: Cash Balance Hides Strength

May.13.10 | About: Risk (GEORGE) (RSKIA)

Thesis

George Risk (OTCPK:RSKIA) is currently trading for about the value of their cash and marketable securities. However, unlike most companies that trade for the cash values, they have a relatively stable, profitable business selling alarms and switches. The cash value gives the company a significant margin of safety, and the profitable business has some growth opportunities.

What do they do?

George Risk makes a variety of products, including keyboards. However, the vast majority (over 90%) of revenues come from making alarms. One of their alarms is a pool alarm, which alerts pool owners when someone tries to enter their pool. The state of Florida has required every pool owner have this device, which has made Florida one of George Risk’s largest markets. Most of their products work on the outside of the home.

Note that the business is strongly correlated with the housing market. Obviously, new homes and pools require new alarms, and an old home probably already has one installed. Still, even with the hit to the housing market, the company has been both consistently profitable and generated excess cash.

Do they have a moat?

Yes, a decently strong one. George Risk focuses on making niche products in the security alarm business. They make small, customized products that are not scalable, so larger competitors can’t compete with them because it wouldn’t make sense for them to (they can’t generate the operational efficiencies). Because it is a small niche market, potential competitors are discouraged from entering because the investment in technology and entering the field would outweigh the benefits of sales and profits.

The company’s moat can be seen in both their ROIC and ROE. At first glance, their ROE has been consistently around 11% for the past ten years, dipping to just 2% in the most recent year due to the economic crisis. However, if you strip out excess cash for the past ten years, the numbers tell a much different story. There are a lot of definitions for excess cash. I define it as cash and short term securities in excess of current liabilities and long term debt minus current assets. Using this definition, George Risk has consistently had returns on assets and between 35% and 45% for the past ten years, dipping to about 8% in the most recent year.

Operational Risks

One customer represents about 43% of sales, which gives them customer concentration. However, since the customer has represented this level of sales since (at least) 1997, I’m willing to somewhat discount this risk.

The major risk for the investor is the major risk of most small cap companies: ownership concentration. The CEO, Ken Risk, is the son of the founder and owns over 50% of the stock. While I think he’s done a great job managing the business, I question his capital allocation decisions. The company has a tremendous amount of excess cash and securities and has hired a professional to manage them. However, the company has seen no benefit from this investment, as it looks like the professional has consistently generated losses in the investments. Also, the company made a small ($200k) investment in a limited land partnership in 2003. It has been recorded at cost on the balance sheet since then. However, I can’t find any more information on this investment in any of the company’s filings; it literally just appeared in the company’s 2003 balance sheet with no description or anything. Combined with the lack of disclosure on the money manager (who is it? What specifically does he invest in that constantly loses money? Why not return that excess cash in some way?), it is clear the company is run very much as a private company by the CEO.

As a side note, the company also leases an airplane for $27,000 per year. It is co-owned by the company and Ken Risk. This lease has no bearing on the investment, but it just upsets me that the CEO is using the company to pay for this lease when I can see no reason why the company needs a plane and believe the CEO should just pay for this himself. The lease speaks more on the poor capital allocation decisions of the CEO.

Valuation

RSKIA currently sells for under $4.50 per share. They have net current assets (current assets minus all liabilities) of $5.05 per share, of which almost all is cash and the investments in securities. In addition, the company owns two manufacturing plants that total just over 50k square feet, plus the $200k investment in the land partnership.

I think the best way to value RSKIA is to separate the excess cash and then value the underlying business. The company averaged about $0.4 per share for the past ten years. Considering the strong ROE and ROIC mentioned above, plus the company’s competitive position, I would feel comfortable putting a conservative multiple of 12 on those earnings. That would give the company itself a valuation of $4.80.

The excess cash (by my calculations as noted above) the business owns total about $4.44 per share. Putting the two figures together gives a price target of $9.22 per share. I personally think there is further upside even from that price, given the great ROE and ROIC, but I’m comfortable using the conservative price because of the risks concerning the CEO.

Catalysts

No real catalysts. However, the company currently has a 3.8% dividend yield and occasionally buys stock back, so you are getting paid to wait for something to happen.

Price Target

As noted above, I have a price target of $9.22 per share on RSKIA.

Note: I first stumbled upon the idea at Rational Walk. I feel my own analysis has included most of his main points, but I encourage you to read his analysis here and here.

Disclosure: I own RSKIA, and am actively trying to accumulate more shares.