CSP Inc. (NASDAQ: CSPI) develops and markets IT integration solutions and cluster computing systems. It trades for a market cap of just $14.5 million despite having NCAV of $13 million, zero bank debt, improving revenues and profits and a share repurchase program that it is actively using.
The key to CSPI’s valuation is in Item 1A. Risk Factors found in its most recent 10K. While this section often contains boilerplate language without really providing insight into the company, it is still important to at least skim through in search of unique disclosures. Imagine my surprise when I found this disclosure:
Our largest customer for fiscal year 2010 acquired one of our largest competitors and this customer also expects a downturn in business from one of its own customers that was creating significant demand for our products. These events could result in a significant reduction in our sales volume for fiscal 2011 and beyond.
Our largest customer for fiscal 2010 is a large hosting company that provides outsourcing of computer infrastructure, storage and communications resources. Our sales to this customer were $22.5 million for fiscal 2010, which comprised 24% of our total revenues. Two events occurred late in our fiscal year 2010 that may have a significant impact on our sales volume for fiscal 2011 and beyond.
First, our customer expects a downturn in business from one of its own customers that was creating significant demand for our products. This will likely have an unfavorable impact on our sales because our customer may no longer need to purchase the same volume of products from us in fiscal year 2011 as they did in fiscal year 2010.
Secondly, this customer has acquired a major competitor of ours that supplies some of the same IT networking equipment that we were supplying to them during fiscal 2010. We believe that in the future, it is likely that this customer will procure some or most of these products from our competitor rather than purchase them from us.
In short: this company is almost certainly going to see a dramatic decrease in sales to a customer that represents 24% of its total revenues. Since we know this company is not trading below NCAV, it is not an investment based on assets, and with the uncertainty surrounding the company’s future revenues and earnings, we cannot consider this an earnings play.
As such, despite the positives listed at the beginning of this article, I am not investing. However, I will add it to my watchlist to see how the sales play out (with any luck the decline in revenue will send the shares into a tailspin far exceeding an appropriate amount, making for an attractive value opportunity, though I should caution the shares would have to drop significantly for me to take another look).
Disclosure: Author holds no position