"Watch the downside, the upside will take care of itself"
- John Gruss (John Paulson's mentor)
TESSCO (NASDAQ:TESS) is a leading provider to the wireless communications industry, an industry that is constantly growing.
TESSCO's guiding vision is to be "The Vital Link" between buyers and manufacturers. For its customers, TESSCO provides a total source of product knowledge and solutions. For its manufacturers, TESSCO presents, markets and sells their products as a part of a customer solution.
The downside of TESSCO is looking smaller and smaller every quarter. Investors were worried before that its biggest customer, AT&T (NYSE:T), represented 30% of its revenues and was too much of a risk. Now, it only represents 16% of revenues. Q4 FY 2010 total revenues was $130.5M, and $39.3M of that was from AT&T. Q4 FY 2011 total revenues was $130.3M, and $20.8M was from AT&T.
"In the fourth quarter, purchases from customers other than our largest customer grew by 21 percent compared to last year," said Chairman and CEO Robert B. Barnhill, Jr.
Because of this, Tessco is in a better position with less risk and more opportunities for growth than it was at the same time last year. The company also has more assets and less liabilities than it had in Q4 last year. Last year at this time the book value was $8.9 per share, and this year it's $10.1 per share. Yet, the stock traded for $17 at this time last year, a 40% premium to the share price today. Why the huge difference?
My assumption is that it's because of its rapid growth in income from FY 2008-2010 (note: fiscal year for TESS is about nine months ahead of the calendar year) and the market expected this growth to continue. From FY 2010 to FY 2011 revenue grew a decent 14% and net income grew 9%.The stock plummeted earlier this year because of a decrease in sales from AT&T which caused 2011 guidance to be lowered. Now representing 16% of revenues, AT&T is still their largest customer and this still poses a risk but one that's smaller than before.
Maybe the stock is also depressed because the market is concerned about further declines in sales from AT&T or other big customers. I find this unlikely. AT&T uses TESSCO for their delivery services, which it still needs. The main reason why companies buy products from TESSCO is because they deliver quickly, at high accuracy, and with guaranteed availability which is better, quicker, and more flexible than what the manufacturer could deliver on its own. AT&T doesn't need as many products from TESSCO as before because most of it was iPhone accessories. Since AT&T is no longer the exclusive iPhone carrier, iPhone related sales will be reduced. There doesn't seem to be any other issues that caused AT&T to reduce TESSCO's business.
For FY 2011, TESSCO's EPS was reported to be $1.27. This is at the top of TESSCO's prediction of earnings between $1.20 and $1.27 for the quarter. Its current PE is 9.3. With projected EPS for Q1 FY 2012 of $0.37 to $0.45, earnings for FY 2012 can be expected to be between $1.50 and $2.00 a share. This kind of growth, which is expected by the company, will catapult the stock back up. TESS could easily grow 15-30% this year, and next year retest its highs.
TESSCO offers products in three business segments: network infrastructure, mobile devices and accessories, and installation, test and maintenance, which accounted for approximately 35%, 55%, and 10% of 2010 revenues, respectively. From the big reduction in sales to AT&T, the mobile accessories segment, TESSCO has developed a higher diversification among its business segments. This decreases risk.
TESSCO provides customers with advice and helps them figure out the best product for their wireless needs. TESSCO doesn't charge a consulting fee. It just gives advice to help out the customer and sell them their products and services. If a university wants to go wireless, for example, TESSCO will explain the best way to go about it and then engineer and install the network infrastructure to give the university wireless connectivity.
Success breeds success in the wireless supply chain business more than other kinds of businesses. As Tessco grows its customer base, its risks decline. TESSCO sells so many different products, it can persuade its customers to tack on more at a discount.
With more customers, TESSCO doesn't have as much of an inventory-buildup risk. If one customer abruptly stops buying a product, TESSCO has plenty of other interested customers to sell it to, so it won't sit in its warehouse for too long.
More Risks to TESSCO
- Barriers to entry are low. There's not much to prevent a distributor from deciding to also sell the same products that TESSCO does.
TESSCO's large customer base and purchasing relationships with over 420 manufacturers give it a significant edge over new entrants. The bigger TESSCO gets, the bigger the edge over competition because it will be able to offer more services and have better economies of scale than new entrants.
- Some competitors have substantially greater capital resources and distribution capabilities than TESSCO.
For obvious reasons, this risk also decreases as TESSCO grows.
TESSCO has many competitors in the wireless communication distribution industry. These include: Hutton Communications, Brightpoint (NASDAQ:CELL), Embarq Logistics, Westcon, Comstor, Tech Data, Ingram Micro (NYSE:IM), Superior Communications, Site Pro 1, Wincomm (OTC:WINC), Talley Communications, and Alliance Semiconductor (ALSC.PK).
Looking at each competitor, I don't see any particular one that would be a big threat to TESSCO. Most of them are small and privately owned with specialized products and because of TESSCO's diversification, wouldn't be able to steal a big chunk of revenue from TESSCO.
Brightpoint is the biggest competitor and it could possibly take market share from TESSCO's mobile phone and accessories segment.
- Consolidation among wireless carriers could result in the loss of significant customers.
What comes to mind is the AT&T and T-Mobile merger. From speaking to TESSCO investor relations, I learned that T-Mobile isn't a significant customer so the merger shouldn't affect TESSCO for better or for worse.
TESSCO was offered to be bought out in September 2010 for $15.50 by Discovery Group. TESSCO rebuffed the offer saying it was "grossly inadequate". The company seems to be in better shape now than it was then, I'm wondering if Discovery Group would offer the same price now that their AT&T revenues has declined, or if TESSCO would accept the offer now.
Twice, TESSCO was recognized in Baltimore Magazine as one of Maryland's best places to work in terms of employee benefits, positive teamwork environment, and company success.
With the lack of downside risk, and lots of upside potential, TESS looks to be a buy for most portfolios.
Disclosure: I am long TESS.