MicroPac: Net-Net With A Cash Flow Positive High Barrier Business

Mar. 6.12 | About: Micropac Industries, (MPAD)

MicroPac (OTCPK:MPAD) is a small Texas company trading at liquidation valuation. What is overlooked is the quality of the underlining business and the current operator. Micropac Industries, Inc. (Micropac) manufactures and distributes various types of hybrid microelectronic circuits, solid state relays, power operational amplifiers, and optoelectronic components and assemblies. Micropac's products are used as components in a range of military, space and industrial systems, including aircraft instrumentation and navigation systems, power supplies, electronic controls, computers, medical devices, and high-temperature (200o degree Celsius) products. The Company's products are either custom (being application-specific circuits designed and manufactured to meet the particular requirements of a single customer) or standard components.

A quick look at the balance sheet reveals that the company has $10.5mm of cash, $1.9mm of account receivables, and $5.3mm of inventory. These current assets equates to $17.7mm of value, about $2.5mm more than the value of the current market cap of $15.2mm at $5.90 a share. Further, the company owns 31,200 square foot of manufacturing real estate in Dallas, TX. Assuming a conservative replacement cost of $50 a square foot, the real estate is worth $1.5mm. Netting out total liabilities of $2.1mm, the shareholder is entitled to $17.1mm of mostly liquid hard assets net of liabilities. This represents a value of $6.62 per share with $4.05 of this in the form of cash and cash equivalents. The investor in the company has plenty of downside protection via the balance sheet.

$10.5mm cash + $1.9mm AR + $5.3mm Inv + $1.5mm Real Estate - $2.1mm Liabilities = $17.1mm Net Assets

Market Cap = $15.2mm

MicroPac also has significant value in its operation. The company manufactures high reliability electronic components used in defense, military, industrial, and medical applications. While most electronic components are highly commoditized, MicroPac's products occupy a niche market where performance is of paramount importance. Imagine if you're firing PAC 3 missiles at your opponents and it fails in mid air because the manufacturer decided to use a cheap substandard component. Or if you're a satellite manufacturer and the satellite malfunctions prematurely while orbiting in space. Now your $20 million equipment just turned into a pile of metallic space junk. MicroPac's product stresses high reliability in high temperature, pressure, radiation, and corrosive environments application. It is incredible how expensive some of the products are. For example, small coin sized products can easily cost $50 or more. There is also a high barrier to entry as most of the products require stringent military certification and can't be readily outsourced to cheaper labor countries such as China. See the corporate presentation for the company's products and history.

Trailing 3 and 5 year EBITDA has averaged $2.8mm. It is also important to note that since the current CEO took over in 2005, he has grown the annual revenue from roughly $13mm to $20mm a year. At $13mm, the company was barely profitable given the company's overhead and fixed cost. With the incremental sales since 2006, the company has grown its cash balance by about $6mm. Given the quality of the management and the business, a 4-5X EBITDA multiple for the business is very reasonable. This would equate to $11.2 to $14mm for the business.

Adding the $17.1mm of net assets and the operating business gets us to $28.3 to $31.1mm valuation which equates to $10.96 to $12.05 per share.

The stock is cheap primarily due to the fact that it is a very small micro-cap with no sell side coverage. It traded as high as $12.01 per share a year ago when it was coming off a robust 2010. During the second half of 2011, the stock sold off along with the broader market. In the second half of 2011, the company did experience YOY declines in sales and currently has a smaller backlog. This is largely due to the lumpy nature of the company's business. A couple contract wins can get them back into the $20 million revenue average that the company has experienced in the past few years. Recent stock purchases by the CEO in the $5.25 range leads me to believe that there is no material impairment in the company's business. Stock purchases by the CEO equates to a sizable amount of his post tax annual compensation.

The stock is also cheap due to the fact there is one large shareholder who owns 75% of the shares outstanding. However, the large shareholder and the management team have not done anything to destroy value in the last decade. They did buy back about 20% of the stock many years ago at a slight premium to book value. The company pays a $0.10 dividend, which is just under 2%. Without a doubt, the company can afford to pay a higher dividend, buy back stock, or return of the cash to the shareholders. My take is that unless you're an activist investor who likes to force management to pay a special dividend, the 75% ownership is somewhat irrelevant if you're passive investor.

With all net-nets, it is important to realize that value can be destroyed if the cash is used to make bad acquisitions. Hence, proper sizing of this name is recommended either as a part of an overall net-net basket or as a smaller position in your portfolio.

Disclosure: I am long OTCPK:MPAD.