The question I have posed, and time will tell whether or not it will be answered, is "has the management of Syntax-Brillian (NASDAQ:BRLC) received the wakeup call provided by the market over the last several months?" While I was in the middle of writing this article on Tuesday afternoon, I didn't expect to get an answer so quickly. As indicated by the (2) Form-4s filed after the bell Tuesday, CEO James Li and CFO John Hodgson just purchased, respectively, 100K and 16.2K worth of stock (at about $3/share). As such, the tone of this article will be somewhat different (albeit not entirely different) than what I originally intended.
This wakeup call was barely audible in March-April, became much louder in May, and has been screaming since September. Tuesday's closing price of $2.79 is the lowest closing price since BRLC closed at $2.74 on July 12, 2006 (the stock price rose to $3.75 the very next day and didn't close under $3 again until last week), and 74% lower than this year's highest closing price of $10.74 on January 5, 2007.
Depending upon how it is calculated, Tuesday's closing price is within +/- 5% of the tangible book value of the company, which means that the market is essentially valuing Syntax-Brillian's ongoing business and current product lines as being worth absolutely nothing. This is severe indictment of Syntax-Brillian's management team since it represents the market's current opinion that BRLC's shareholders could be served just as well by having the company dissolved with the remaining assets distributed to shareholders.
By comparison, consider two small/mid-cap companies that currently enjoy the type of buzz that Syntax-Brillian had during the 2nd half of 2006 and the 1st half of 2007: Taser International, Inc. (NASDAQ:TASR) and Crocs, Inc. (NASDAQ:CROX). If these companies were given the same type of valuation (i.e., net tangible value) as Syntax-Brillian, these companies would be trading at $0.79 for TASR (instead of the current $13.44, which is about 30% lower than TASR's October high) and $2.88 for CROX (instead of the current $38.60 for Crox, which is nearly 50% lower than CROX's October high).
Using another common measure of sales/price ratio (while using the last 4 quarters revenue), BRLC is trading at a sales/price ratio of around 0.34 ($260 market cap/$762 revenues). By comparison, if TASR and CROX were trading at such a ratio, their stock prices would respectively be $0.47/share and $3.61/share. Based upon this vast discrepancies in valuation, the question that begs to be asked is why?
I am not familiar with what CROX and TASR are doing right, but I do know what BRLC has done both right and wrong. Going into last year's stockholder meeting in November of 2006, BRLC was trading in the $8s with a prior four quarters of revenue totaling $253M. Flash forward 12 months and going into next week's stockholder meeting, for the prior four quarters, BRLC has total revenues of $762M. During those 12 months, BRLC has also gone from having a couple of SKUs in Circuit City, Office Depot, and Staples to adding several additional models to Sears, Target, and Costco with Best Buy just announcing that they will be selling O"levia LCD TVs as well. Based upon managements continued statements, the demand for O"levia LCD TVs far outpaces BRLC's ability to supply the LCD TVs. In fact, management has indicated that demand for BRLC's products is three times more than what BRLC can currently provide.
The inability of BRLC to supply the number of the numbers of product demanded by retailers has been both BRLC's blessing and curse. To delve into exactly why BRLC's price has dropped from the $7s, $8s and $9s experienced from Nov. of '06 through May of '07 would make this article far longer than it already is. However, the root cause of most of BRLC's problems have been centered on BRLC's inability to meet demand and the steps BRLC has tried to take to meet this demand. For example, BRLC added about 33M shares to its share count with one secondary offering and three private placements to BRLC's suppliers over the past 12 months.
Recently, during the September conference call, BRLC revised revenue guidance downward for CY2007 from $1.1B-$1.3B to $0.9B-$1.1B as a result of a credit crunch experienced in Taiwan with regard to its suppliers. This revision in guidance knocked $2/share off of BRLC's share price in a single day. Shortly thereafter, both BRLC's CEO and CFO were replaced with the aforementioned James Li and John Hodgson. The prior CEO and CFO were holdovers from the original Brillian (i.e., the business unit that BRLC recently announced that it was divesting), whereas James Li was the founder of Syntax, which produces LCD TVs and makes up 90+% of BRLC's current revenues.
As of James Li's taking over as CEO, he has introduced a 120-day action plan, divested the LCoS division (which has never turned a profit), secured $250M in financing, and announced a new strategy for sales in China to replace their current sales model (with 120-day payment terms) with a royalty model that frees up BRLC's operating capital for the North American market, which has much lower payment terms (i.e., 45-60 days). In so doing, BRLC should be able to use its operating capital more efficiently.
However, prior to the November conference call, the share price (although fluctuating considerably during this time) settled at a number very near the closing share price the day after the September conference call. Although it took about 2 weeks for its full effects to be realized, the share price dropped another $1/share after the November conference call. This was a result of a conference call in which management neither clarified guidance for Q4 and CY2008 nor clarified BRLC's new royalty plan. Instead, management further muddied the waters with their comments. It has been the market's uncertainty as to BRLC's future that has led to the market to not attribute any value to BRLC's future business prospects based upon BRLC's current valuation.
In order for BRLC to address its all-time poor relationship with its investors and the market, as whole, I have the following suggested "7-day action plan" for BRLC management to act upon prior to the shareholder meeting next Thursday, November 29, 2007.
1) Address the Short Issue
BRLC's reported short interest has continued to be a large percentage of the float, and BRLC has also been on the naked short list for 200 straight days (9th longest period). Particularly, over the last several months, BRLC's daily trading evidences manipulation by short sellers, who appear to have the stock price under their thumb
BRLC's past management team had the philosophy that the short problem would go away by itself. However, it is readily apparent that not only has the short problem not gone away, it has materially affected the company. For example, BRLC got a much lower price ($5.75/share) in its secondary offering in May than expected and as a result, had to issue more shares to get the desired amount of capital.
Back on October 4th, BRLC filed an 8-K, which indicated that BRLC's bylaws had been changed to enable the company to participate in a direct registration system administered by the Depository Trust Company. In so doing, investors can register their shares to prevent them from being loaned out to short sellers. Coincidentally, the very next day, BRLC's stock price closed at $4.99 after closing the previous day at $3.97. However, since then, no further details have been announced as to how investors can participate in this direct registration system.
To get the short monkey off of BRLC's back, BRLC needs to take a clear and public stand against the short selling that has, in part, attributed to the decline in BRLC's stock price. In so doing, BRLC should clearly publish, in its corporate website, how investors can participate in this direct registration system. Another approach would be borrow from the tactics of Overstock.com (NASDAQ:OSTK), which has been very successful in the last 12 months in fighting their short issue.
2) Stock Buyback
During the conference call on November 8th, one of the analysts asked James Li whether or not a stock buyback was in the works. James Li response was that he would consider using his "own money" to buy stock "as long as legally allowed" (i.e., when no deals were in the works). As of Tuesday, we know that James Li was true to his word. One would hope that the rest of the Board of Directors would follow James Li lead.
Although this has been a proposal that I've been against for the many months I have heard it being bandied about, I now agree that in addition to BRLC management using their own money, BRLC management should also consider using the company's own money to buy back shares at this time. During the public offering in May, BRLC sold approximately 26.5M shares at $5.75. At the current share price, BRLC should be able buy back 10M of those shares for prices between $2.75-$3.25/share. Considering both income taxes and a reduced share count, the "profit" realized by this "short sale" and buyback would, in essence, add $0.13 EPS to BRLC's bottom line (($27.5M/85M shares)*39% tax rate).
For a company that may have anywhere between $350M-$550M revenues in the current quarter, spending $30M to buy back 10M shares is a great investment and gives the market a clear indication as to management's confidence in the company and their belief as to how undervalued the stock has become.
The Board should authorize company management to use, at is own discretion, some set amount of funds (for example, $30M) to be used to buy back BRLC stock. An announcement of such plan would immediately and significantly improve investors' confidence in the company.
3) Address NASDAQ deficiency letter
On October 17, 2007, BRLC announced that it received a NASDAQ deficiency letter. As noted by the company, "[t]he company was expecting receipt of this letter, as the failure to meet the independent director requirement is a result of the recent appointment of John S. Hodgson, a previously independent director, as the company's new Chief Financial Officer."
The cure to this deficiency is simple, name a new director, in John Hodgson's place, who qualifies as an independent director. Although the company has until March 31, 2008, to cure this deficiency, and company has stated that "the company expects to cure the deficiency in the near future," every day this deficiency is not cured is a day that prospective investors in BRLC are faced with glaring announcement in financial websites and/or through their brokers that BRLC faces possible delisting. Although this is a small straw on the camel's back, it provides more ammunition with which shorts can attack BRLC and erode current and prospective investors' confidence in BRLC.
Prior to next week's shareholder meeting, BRLC should present a slate of directors for election that addresses this deficiency.
4) Drop the proposed 60M increase in authorized shares
One of the matters being brought to vote at BRLC's shareholder's meeting is a proposal to increase the authorized share of common stock from 120M to 180M. The rationale for this proposal is that:The Board of Directors believes that the availability of such additional shares will provide our company with the flexibility to issue common stock for possible future financing, stock dividends or distributions, acquisitions, stock option plans, and other proper corporate purposes that may be identified in the future by the Board of Directors, without the possible expense and delay of a special stockholders' meeting.
This statement is merely boilerplate language that provides no clear reason why the company needs these additional shares at this time. James Li has already emphatically admitted in the last conference call that he believes that the stock price is undervalued (and that stock price at that time was 40% higher than it is today), and the recent $250M loan obtained by BRLC already provides more funds than could be raised at the current share price.
For a company that had only around 60M shares outstanding 12 months ago, the notion that the company could have 180M shares outstanding at some time in the near future is one of the biggest fears of shareholders. At the time of the 2006 shareholder meeting last November 30th, the stock price was $8.32/share. Since then, approximately 33M new shares have been issued and the stock price has plummeted to $2.79/share.
BRLC's request to increase the share count when BRLC's share price is severely undervalued has led some to question BRLC management's commitment to maximizing shareholder value. Given certain of BRLC management's ties to Kolin and other Taiwan/Chinese manufacturers, questions have been long been raised as to whether BRLC management is committed to maximizing BRLC shareholder's value or whether BRLC management is solely committed to increasing the bottom line of BRLC's suppliers by maximizing revenue (and thus volume) at the expense of BRLC's profits.
Personally, I have always believed the considerable holdings that BRLC management has in BRLC stock would provide sufficient motivation (outside of management's legal obligation to maximize shareholder wealth) for management to act in the best interest of the shareholders. However, the pursuit by management of these additional, unneeded and currently undervalued shares (presumably to finance future growth) has given me pause to reconsider my position and publicly state my opposition to this proposal. However, James Li's recently announced purchase of 100K shares has renewed my faith in BRLC's commitment to maximizing shareholder value. However, although I may have been swayed, my opinion is not shared by all investors in BRLC.
Until BRLC's stock price has been raised to reflect a more reasonable valuation and until BRLC management has set forth a reasoned explanation as to why BRLC needs to increase its authorized share count to 180M shares when less than 100M shares are currently outstanding, BRLC management should shelve this proposal.
Whereas the prior four proposals are intended to reinvigorate positive investor sentiment towards BRLC and its management, the next three proposals are intended to address the uncertainties that BRLC's management has introduced with regard to its future guidance with regard to revenues/earnings.
5) Clarify China strategy
In a presentation to investors on November 5, 2007, James Li briefly described that BRLC would be changing in China sales strategy to employ a "royalty" model. Instead, of selling products through SCHOT, a distributor with 20 years history in Asia, as BRLC has done since 2004, BRLC will now be engaging in a royalty strategy in which BRLC not be responsible for financing the production of product. Likewise, BRLC will not have funds tied upon in accounts receivable for 120 days, which is the typical term in Asia. Instead, BRLC will have design/quality control over the product shipped under the O"levia brand name, and for this BRLC will receive a royalty.
Where confusion was introduced by BRLC management regarding this strategy is the following items that BRLC managements needs to clarify:
i) Will this royalty strategy apply to just China or will it apply in other regions, such as North and South American as well as Europe?
ii) On page 4 of the 10Q filed last week, it was stated that BRLC has "recently commenced selling to a new distributor in Asia." Since under the royalty plan, as currently understood, BRLC would not be responsible for financing/manufacturing of product, does this "new distributor" represent a departure from the royalty model?
iii) Referring again to the "new distributor," another strategy floated by BRLC regarding China the last couple of months was the creation of a subsidiary in Taiwan/China who would sell directly to Chinese retailers. SCHOT would continue to market the product, but BRLC would take over the account receivables from the retailers, and these accounts receivables could be factorable (in contrast, BRLC has previously been unable to factor the AR from SCHOT). Thus, BRLC needs to clarify whether this new distributor is part of this alternative strategy and whether or not BRLC will be proceeding with creating a subsidiary in China/Taiwan.
iv) Who will be making the products being sold under the royalty program? and will this subtract from the current 550K units/quarter capacity that BRLC described in its last conference call?
v) Last but not least …. assuming that BRLC is proceeding with the royalty strategy, what are the royalties (percentage royalty and product volume) that BRLC foresees obtain in the future?
6) Clarify current production capacity and capacity into CY2008
As stated in the current CC, BRLC has a current maximum capacity of about 550K units/quarter and last quarter's ASP was around $556. As such, including Vivitar revenues, BRLC has a capacity to generate about $300-$350M in revenues per quarter. However, when the $250M financing deal was announced on October 30, 2007, James Li was quoted as saying that it enables BRLC "to achieve year-over-year revenue growth of 60% to 80% in calendar 2008." At the time this statement was made, BRLC's guidance for calendar 2007 was around $0.9B to $1.1B. As such, assuming a best case scenario of $1.1B + 80%, BRLC management foresaw the potential of $2B in revenue for CY2008. This means that BRLC would have to increase its current production capacity from around 550K units/quarter to, on average, to about 850K-1,000K LCD TV units/quarter (depending upon ASP and contribution by Vivitar).
Prior to the last conference call, based upon BRLC management's past target models of 9.3% of revenue for net earnings and a tax rate of 39%, it was easy for investors/analysts to estimate future earnings based upon BRLC management's stated revenues targets. For example, assuming that BRLC revenue ranges from $1.45B to $2.0B for CY2008, one could calculate (based upon about 95M outstanding shares) an EPS range of $0.87 to $1.13. However, during the last conference call BRLC management changed the gain with regard to how revenues will be calculated (because of the royalty model) and didn't provide sufficient information for investors/analysts to prepare new models.
BRLC management needs to clarify exactly what type of growth BRLC is attempting to achieve and explain how BRLC intends to achieve this growth as it relates to production capacity. In particular, BRLC should clearly describe all the ODM/EMS partners BRLC is working with to produce O"levia-branded LCD TVs (and soon Vivitar-branded LCD TVs for Europe). Moreover, for each of these partners, BRLC management should share the following information to investors:
i) currently operating and planned plants,
ii) the current/future production capacity of each plant that will be dedicated for units not sold under the royalty program,
iii) the general product mix at each plant,
iv) the geographic market being served by each plant, and
v) for those plants under construction/increasing capacity, a rough timetable for the increase in production capacity.
By providing this type of information, BRLC will give analysts/investors the type of information needed to predict BRLC's future production capacity and gauge BRLC's ability to meet their previously guided revenue numbers. Until BRLC management gives analysts/investors some concrete information regarding BRLC's future business prospects, the investment community will continue to give zero value to BRLC's future business.
7) Be open with investors and don't stop being open with investors
BRLC's last conference call could be a case study as to how not to introduce the new CEO to the investment community. After a big lead up in which James Li, just 3 days before the conference call during an investment conference, promised that investors would "love" the new China strategy, which he would clarify in the conference call. However, James Li failed to follow through on his promise. Instead, his description of the China strategy added very little to what James Li had already described in the presentation and interviews preceding the conference call.
During the Q&A part of the conference call, James Li also danced around issues (i.e., Q4 guidance and CY2008 guidance) that he should not have had to dance around. Also, although I recognize that James Li is not a native speaker and this was his very first conference call, there were times when I could sense the extreme frustration in the analysts' voices as I heard them ask their questions and respond to James Li's answers (or non-answers in certain circumstances). Instead of being upfront with what BRLC could tell investors, many analysts had to pull hard to get information out of James Li that should have been presented upfront (e.g., the unit production capacity by quarter).
Moreover, after giving guidance for the current quarter (and also future quarters) during every conference call since the merger of Syntax and Brillian, investors received neither during the November conference call.
As a result, James Li should consider the following advice:
i) Don't withhold information, even if he thinks it could be construed as being negative … by withholding information, BRLC takes two hits. One hit is that the market will assume the information is negative and discounts the stock price according and the second hit is when the market actually learns the negative news and further discounts the stock price.
ii) Be consistent with how and when company information (e.g., guidance) is disseminated. In the past, BRLC had a history of giving revenue guidance for the present quarter during the conference call (typically taking place at the midway point of the quarter) and updated that guidance 1-2 weeks after the end of the quarter as well as updating guidance for the subsequent quarter at the same time. Most recently, BRLC did neither. Any change from convention will always be treated negatively by the market, which abhors surprises. Not only should BRLC management have a consistent plan for providing information about the company to investors, if BRLC believe that changes to that plan are necessary, BRLC should give investors notice before those changes are implemented. As just an example, providing unit shipment numbers (for both O"levia and Vivitar) on a monthly basis would go a long way to help investors/analysts understand BRLC's ongoing business.
iii) Update investors on issues of concern. For example, a very large portion of BRLC's AR is attributed to SCHOT. As such, information that significant payments were made by SCHOT would reduce investors' fears that SCHOT will stiff BRLC. Also, BRLC put a large part of the blame for the September reduction in guidance on the credit crunch that occurred in Taiwan over the summer, yet BRLC management has not yet updated investors on this issue. For BRLC's stock price to reflect the value BRLC's management places on the company, investors need to have same information available to management and in a timely manner.
As I noted earlier, James Li's purchase, late last week, of 100K shares on the open market with his own funds is a great start in helping BRLC rebuild its credibility with the market. However, BRLC management still has a long ways to go before BRLC can regain the confidence the market had in BRLC 12 months ago. Although I currently remain an investor in BRLC, my confidence has waned these last several months.
Although I believe in James Li's vision as to this company, I'm not sure if current shareholders will enjoy the fruits of James Li's labor unless BRLC raises its share price to a reasonable valuation. Given the current valuation for this company and its potential, BRLC is undoubtedly on the list of some private equity firms as a takeover and reclamation project. A private equity firm, with sufficient capital to address BRLC's major concern (which is the ability to increase manufacturing capacity and to fund the demand for product), could probably get revenues to $5B/year within a couple of years and net earnings to around $230M/year (using BRLC's reduced estimate of 7.5% net margins and a very conservative 39% tax rate). The $230M in after-tax earnings, at Tuesday's share count of around 95M, yields an EPS of $2.42.
With a PE ratio of 20 to 25, which is typical for a high-growth company, and even after paying a 100% premium for the company at Tuesday's share price, a private equity firm could reap an extremely nice profit taking the company private and then public again after a couple of years. The problem for BRLC's current shareholders is that shareholders buying today, despite making 100% on their investment, would miss out on the potential, additional 10x increase in value that a private equity company could possibly get with their investment.
To echo a statement made BRLC's management in several conference calls, BRLC has a bright future, but it still has many obstacles to overcome. I hope BRLC's current management team recognizes that these obstacles aren't just about execution but also regard clearly communicating with investors. However, if BRLC management doesn't heed the current wakeup call being issued by the market, I feel that things may get worse before they get better.
Disclosure: The author has extensively commented on BRLC under the pseudonym "traveler20202" for over 2 years. Currently, "traveler" is a moderator for a message board dedicated to discussions about Syntax-Brillian. The author has a long position in BRLC.