About two weeks ago, I wrote about Universal Power Group (UPG) as a potential value investment. The company contacted me to respond to some of the criticisms I had laid out. As such, this post will feature its responses. I was also given the opportunity to ask some follow-up questions, and I asked a couple of tough ones, particularly on the issue of the company's record in being shareholder friendly. To the company's credit, every question was answered -- even the rhetorical, sarcastic ones to which I already knew the answer. Here's how it went down:
I originally wrote: UPG already had $11 million in debt against almost no cash, so this acquisition increases the investment's risk as it adds to the company's debt burden.
To which the company responded: With regard to your concerns over acquisitions, the recent agreement to acquire PTI was done to expand an existing UPG business, and is expected to be accretive this year. While investors are naturally interested in how company resources are invested and utilized, UPG’s management team has made it clear it intends to take a very conservative approach toward acquisitions, from both a business and financial perspective. Finally, the primary focus of UPG’s growth strategy is on organic growth, rather than growth through acquisitions. In terms of the company’s debt levels, UPG typically does not maintain large idle cash balances, but instead uses its short-term credit lines with Wells Fargo (WFC) to meet its working capital needs. UPG’s management works very closely with its bankers to ensure adequate availability of cash to fund operations.
To which I asked: Seeing as how $3.3 million represents more than 20% of UPG's market cap, this is a material acquisition. As such, I was a bit surprised that Progressive's financials were not disclosed following completion of the deal. Would UPG be willing to post Progressive's balance sheet at the acquisition date, plus a couple of years worth of income and cash flow statements, so UPG shareholders have an idea of what was just purchased?
To which the company responded: Although the purchase price is significant when compared with market capitalization, from a revenue perspective and when compared with UPG’s total asset base the purchase was not deemed to be material by UPG’s outside auditors or legal counsel. Given the size and competitive nature of the PTI’s business, we will not be disclosing detailed financial statements for PTI, as detailed information on margins and costs would place PTI and UPG at a competitive disadvantage compared with both private competitors and small divisions of much larger competitors, that are not required to disclose such information.
I originally wrote: ... [T]he company has never bought back shares nor paid a dividend, even though shares became very cheap in early 2009.
To which the company responded: ... [A]s a smaller, growing company, excess cash is primarily used to reinvest into the business, rather than paying dividends. Similarly, with a small market capitalization and limited public share float, share repurchases may prove more problematic as they would further reduce market cap and liquidity.
To which I asked: I agree that a buyback or dividend may reduce UPG's market value and/or volume. But when the company trades at a fraction of its net current assets as it has for large parts of the last few years, wouldn't a share repurchase be very accretive to shareholders? Book value per share would rise significantly, even if the firm's market value were to fall Isn't that more important?
To which the company responded: Like all companies, UPG faces a variety of investment choices and constraints on its investment resources. Currently at UPG, we are focused on growing our business, primarily organically, but also through very selective acquisitions. We believe that growing our business is the best way to create true wealth for all stakeholders, as we serve our customers with quality products, create jobs in the communities where we operate, and ultimately drive shareholder value. While it’s true that repurchasing shares would increase book value per share, in the last year, we generated $0.56 in earnings per share, which helped increased our book value per diluted share from $3.90 at March 31, 2010, to $4.48 at March 31, 2011, an increase of 14.9%. This would be the equivalent of repurchasing almost 645,000 shares, which is nearly 1/3 of UPG’s public float, all else being equal. Management and the board will continue to evaluate all options for investing to create shareholder value, including investing in organic growth, appropriate acquisitions, dividends and share repurchases, but at the present time, share buybacks and dividends are not the highest priority.
I originally wrote: ... [T]he company recently passed a resolution to allow the board to re-price options that have been paid out to executives and that are now underwater as the company's stock price has fallen. This is a sign that management wants all the rewards that come with good fortune, without any of the risk.
To which the company responded: ... [I]t’s important to understand that this step was not taken lightly, but was deliberated by the Board for an extended period before putting it to a vote of shareholders. Unlike many companies that have re-priced options, UPG does not have a regular option program for management. In fact the only options issued to management were granted in 2006, just after the IPO with the stock trading at nearly $7. Since that time, the stock market and economy have gone through unprecedented changes, resulting in an overall decline in share price from the time the options were granted. If management was granted new options each year at the current market value, that would certainly have mitigated the motivational issues associated with the original grant. New options granted when the stock was $1, $2 or $3 per share would still be a strong performance motivator, even if the original options were still several dollars out of the money, but unfortunately that is not the case. Further, in their deliberations, the board and management looked at the various options of re-pricing vs. issuing new options, and from a financial perspective, the cost of options expense was determined to be lower with the re-pricing.
To which I asked: ... [W]ould the options have been re-priced upward (rather than downward, as they were) if the opposite market price action had occurred?
To which the company responded: Your question is a good one, and as mentioned previously, there have not been regular annual grants of options to the senior leadership team at UPG. If there were, those subsequent options would have been granted at much lower strike prices over the last few years, or if the stock had increased significantly in price, at much higher strike prices. The fact that no options have been issued to management since the IPO in 2006 has been the main factor giving rise to the re-pricing of those options, and although shareholders authorized the board to re-price those options, as of this date, no action has been taken to re-price them.
To which I asked: In the same spirit of generosity, does the board have any plans to compensate shareholders who purchased at prices pre-collapse?
To which the company responded: While we can understand the rationale of this question, it relates to two very different issues. The option program was adopted by UPG to provide a portion of employee compensation in the form of stock options, as well as a way of motivating employees. Having a management team and workforce motivated to perform and achieve revenue growth, control costs and ultimately generates higher profits to the benefit of all shareholders is essential to the long-term success of UPG. With the original options having a strike price so far from current market price, this plan was not accomplishing it’s purpose of motivating performance and providing a portion of compensation to employees, the board’s actions served to correct this situation so the plan may accomplish these goals.
I originally wrote: As the current CEO is just 38 years old, he likely attained his position with a little hard work and a whole lot of nepotism; his father-in-law is chairman of the board, with beneficial ownership of 45% of the company.
To which the company responded: ... [W]e have disclosed this relationship in UPG’s SEC filings, but it is certainly an issue that raises concerns among investors. I would point to a number of factors that suggest concerns over potential “nepotism” are misplaced. When Ian was elevated to the CEO position, he was named interim CEO, and his performance was subsequently evaluated by the entire board. Only after that interim period was Ian named permanent CEO with the approval of the entire board. Second, I would also point out that Ian has been with UPG for more than 10 years, serving in a variety of roles, and was responsible for leading UPG through the IPO process. Finally, I would point to the company’s performance since he took over as CEO. Despite the difficult economic environment, Ian has led UPG to new growth and record earnings, which benefits all shareholders regardless of the relationship between Ian and Mr. Tan.