Cyberoptics (CYBE) is a tech firm making sensors and inspection systems used in constructing semiconductors and photovoltaic cells. In the past, they've only made a positive net income in 6 of the last 10 fiscal years. So, how does one decide whether to invest? For value investors, one values the firm then purchases shares at a sufficient margin of safety relative to the calculated value. One way to value this firm is using the method of reproduction of assets (like Tobin's Q but with a slight twist), a method noted by Bruce Greenwald, a professor at Columbia University. To put it another way, how much would a firm need to spend in order to take over CYBE's market and market share? For this firm, it's rather simple and this article values CYBE using only three different assets for simplification purposes: cash and securities, other current assets, and research and development (R&D) assets. The end result will produce a conservative valuation on Cyberoptics based on reproduction of assets.
The cash and securities and other current assets are the easiest ones to calculate. CYBE has about $32.3 million in cash, government securities, corporate debt, and CDs. On top of that they have $8.6 million in receivables (for a more detailed analysis, one would determine how much of the allowances should be added back) and $12.2 million in inventories (with $7.1 million in raw materials, $1.3 million in works in progress, and $3.9 million in finished goods). For sake of this article, we'll assume all other assets on the balance sheet are worth $0. For sake of conservatism, we'll discount both the receivables and inventory by 50% and from now on show the non-discounted results in parenthesis. So we now have receivables of $4.3 million ($8.6 mil) and $6.1 million ($12.2 mil) to get a total of cash and securities and other current assets of $42.7 million ($53.1 mil).
The R&D segment is slightly more complicated, primarily because it's not explicitly on the firm's balance sheet. From one vantage point, R&D can be thought of as a capital expenditure rather than an operating expenditure. Any firm that wants to reproduce CYBE's business is going to need a great amount of initial capital to be technologically at par, which will mostly be in the form of R&D. Therefore, some of the past R&D expenditures will be rewritten as capital expenditures in the same manner as property, plant, etc. is written. On the balance sheet, this would increase assets while being offset by an equal increase in equity. This line of reasoning can be found in the writings of both Bruce Greenwald and Aswath Damodaran, a professor at NYU's Stern School of Business. Using the last 6 fiscal years of R&D would be appropriate for this industry and the spreadsheet used to determine the asset and equity values can be seen here. In the end, an additional $24 million can be added to assets and equity.
When added together the reproduction assets add up to be about $66.7 million ($77.1 mil). Using the most recent 10-Q, CYBE has total liabilities, which will not be adjusted, of about $9.2 million. This results in net assets of $57.5 million ($67.9 mil). As of 8/26/2012, the current market cap is at about $44.4 million, revealing a discrepancy of about $13.1 million ($23.5 mil), giving a margin of safety of 22.8% (34.6%).
Now comes the challenging question: given this discrepancy, should one purchase the stock? The discrepancy provides a large margin of safety, but WHY is there this discrepancy? The most likely explanation is due to their recent lack of earnings. For the last 6 months, their net income has been in the low hundreds of thousands compared to the average net income of about $3.7 million over the last two fiscal years. This next quarter will likely yield negative earnings due to declining demand and a $300,000 restructuring charge. Another explanation could be that the R&D needed to enter the market mentioned earlier is overestimated. If the R&D is actually 50% of the $24 million, then the margin of safety is nearly eradicated.
In the end, I believe the resulting valuation of $66 million is highly conservative and shows a possible stock pick that is undervalued.