After the market closed on Monday, Syntax-Brillian announced that it would not be able to complete and file its 10-Q within the normal deadline, due to complexities with its accounting relating to its acquisition of Vivitar in the 4th quarter, 2006. The company stated that it does expect to file the 10-Q within the prescribed period allowed by 12b-25 (5 days). Is Syntax Brillian a low cost manufacturing leader in LCD TVs that is whooping Sony (SNE), Sharp (OTCPK:SHCAY) and Samsung...or is Syntax Brillian just a mediocre company (at best) that is using some questionable moves to mask reality? First, let's separate fiction from reality....
What is reality?
Reality is that 32” Olevia LCD TVs do not sell for $834, as was written in the New York Times. They sell for $599. Reality is that Olevia is not driving the prices lower, market leaders Panasonic (MC), Sharp, Samsung, and Sony are. Reality is that BRLC saw its Balance Sheet further deteriorate in the most recent quarter. Quarter over Quarter: Receivables grew $131 million; Accounts Payables increased $76 Million; and Cash declined $200K to $23.2 million, despite the Company accessing its line of credit to the tune of $83 million.
The unit volumes do not matter if there is not any margin in the business:
Olevia TVs will only sell at a discount to the leading brands (Sony, Panasonic, Sharp, Samsumg, etc.). This is an undisputed fact. The current $599 price for the Olevia 32” TV is not going to make BRLC any margin. With panel costs currently $305, the entire BOM (Bill of Materials) on a 32” TV with the specs of the Olevia 232V is over $500...cost to BRLC (this is Olevia model selling at Circuit City for $599 RETAIL) . Circuit City is suffering from inventory mismanagement and is not making as much money on its TVs as it expected to, but rest assured it is not selling TVs below its own cost. Therefore, the margin that Brillian can make on a 32” TV is very limited at current prices.
In the December quarter 2006, BRLC benefited from a large increase in its average screen size. The increase in screen size enabled the company to register a higher blended ASP, despite very aggressive price declines throughout the industry. Though ASPs increased, gross margins at BRLC were squeezed.
Kolin, an investor/supplier in/to Syntax-Brillian, provided BRLC a total of $31.3 million in "rebates and price protection" in the most recent quarter ($20.4 million in Price Protection pass-throughs, $3.3 million in Market Development Funds, $4.0 million in Technical Development Funds, and $3.6 million in Volume Incentive Rebates). If you take away these questionable payment, the Total Gross Profit in the quarter would have been just $6.46 million on $242.5 million in sales. That is equal to gross margins of 2.6%.
Bulls argue that the relationship with Kolin is strategic and essentially permanent, as are the price protection incentives from Kolin and its suppliers. However, what people haven’t seemed to look at is Kolin’s balance sheet. Kolin, a 40+year old company from Taiwan best known for making washing machines, air conditioners, refrigerators and CRT TVs, is also financially strapped. In fact, BRLC has a substantially larger market cap ($450 million vs. $215 million) and about the same level of cash ($23 million vs. $26 million) but much less debt ($90 million vs. $215 million). In the first 9 months of 2006, Kolin’s FCF was NEGATIVE $28 million. With it’s own gross margins of 14%, increasing debt, and negative cash flows, Kolin’s ability to subsidize BRLC’s P&L has its limits.
Bulls like to point out the number of websites offering Olevia TVs as indication of sales potential. To be sure, management is certainly making it clear that it hopes to increase its sales channels in the United States and potentially in Europe. However, what the bulls fail to note is the lack of incremental profit margin generated. Without the subsidies from Kolin, or the favorable supply terms (typical only when capacity is in over supply), Syntax-Brillian lacks the financial wherewithal to compete with the leading LCD manufacturers. No matter how many retailers BRLC is able to sign up, it is not in a position to generate sustainable free cash flow (after factoring in marketing and administrative costs) without the subsidies from Kolin.
It is important for investors to understand that Syntax-Brillian does not have an inherent cost advantage or differentiation in the market. They are not vertically integrated and have no long-term supply agreements in place. While the industry is in over supply and prices are falling, BRLC is able to finance its operations by factoring its receivables faster than its payables come due. However, as soon as the industry supply becomes tight, the lack of a healthy balance sheet eliminates the ability of the Company to continue operating.
Currently, LPL is seeing its primary customers (LG and Philips) lose share to Sony and Samsung, and as a result LG is more than willing to off load its excess inventory to Brillian (at a slightly higher cost than what it sells to its parents). This price however, is not competitive with Samsung, who has a more efficient line than LPL and because of its complete vertical integration is able to build its TVs at a lower cost than BRLC (the same is true for Sharp). In a cycle of excess inventory BRLC’s business model works because its suppliers bear the inventory cost burden, however in a period of balance or supply shortage, BRLC's model falls apart without a robust balance sheet to support it.
BRLC has been the beneficiary of LG Philips’ (LPL) and other LCD panel manufacturers’ over investment in capacity. This excess investment has allowed for BRLC to gain access to quality panels at competitive prices on very favorable terms. However, the LCD panel industry is one of the most cyclical industries. Panel prices will stabilize and will likely rise slightly. When this happens, the price protection and the terms go away, and Brillian will be forced to compete (without the benefit of subsidies) against Sony, Samsung, Sharp, LG Philips, and Toshiba. Not to mention the third tier brands like Vizio, Insignia, Westinghouse, and Polaroid. In a period where the average screen size increased 10% and the ASP jumped 6% Q/Q Brillian was only able to generate a 2.6% gross margin on its own.
Syntax is not in control nor driving industry prices
Market leaders Sony and Samsung are fighting over market share in the most profitable LCD TV segment (40”). As a result both have been very aggressive in multiple channels with their pricing. Pricing on Sony 40” TVs sets the bar for everyone else’s TVs at the same size or smaller. As Sony and Samsung drive each other’s margins lower, everyone else feels the pain. Interestingly, Sony and Samsung are being pressured by Panasonic in 50” Plasma TVs which are now selling for less than $2,000 and Sharp’s 46” 1080P LCD TV which is also selling for under $2,000. The aggressive price cuts by the leading brands is driving losses in many of the TV divisions. While BRLC points out that this is an illustration of why they are better structured, it also shows that these large diversified companies are committed to market share and have demonstrated time and again a willingness to lose money for years on end in order to solidify market share… Syntax does not have the balance sheet nor the market influence to withstand a sustained attack on prices, especially in the face of stabilizing and potentially rising panel prices later this year.
BRLC is cash strapped and in desperate need of either cash and/or a receivables factoring deal in China.
Syntax-Brillian is a highly leveraged network of relationships that is heavily dependent upon the ability to collect receivables faster than payables are due. While the increased sales into China in the December quarter drove sales and unit growth beyond official expectations, it came at the price of the balance sheet. Terms in China are typically 120 days for consumer electronics goods. However, because LCD TV demand is high in China, Brillian (and its competitors) have been able to get terms down below 90 days. While this sounds good, it is devastating to Brillian. Because the company doesn’t have the cash on the balance sheet to flow the cash cycle, it is constraining the company’s ability to grow. Without a partner willing to factor its receivables in China, BRLC’s growth is on hold until it can raise additional cash. Unfortunately for Brillian, the SEC is taking a longer look at its S-3 and has not yet deemed the registration effective (significantly restricting the financing options available to the company). Indications from the sell-side bulls are that the S-3 will be deemed effective as soon as the 10-Q is filed and the SEC has a chance to review the accounting….and now the 10-Q filing date has been delayed.
The reality is that BRLC is a house of cards built upon related party investments. The top holders list of BRLC reads like a phone book from Taipei, as it should. The company is structured as many Taiwanese companies are, using the working capital of suppliers to leverage capacity and to shorten the cash cycle. As long as the industry trends remain (excess capacity driving lower LCD panel prices) all of the related party investments pay off.
So what is the message? Know what is and is not reality.
P.S. Keep an eye on the Form 4s for related party selling because they will know when the industry dynamics change long before the US investors hear about it.
Full disclosure: Author is a hedge fund manager with a short position in BRLC.
BRLC 1-yr chart: