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John Leonard, CFA
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I focus on the microcap space (market cap below $250 million) because it is one of the most inefficient and "alpha rich" areas of the global equity market, which provides the greatest opportunity to generate alpha through fundamental research. I use a bottom up, investment decision... More
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  • Vicon Industries Trades At ~40% Discount To Book Value With Near Term Catalyst 0 comments
    Jun 11, 2013 3:50 PM | about stocks: VII

    Vicon Industries (NYSEMKT:VII) is vulnerable to a growing activist investor shareholder base that should pressure the company to engage in a leveraged recap in order to extract significant unrealized value on the balance sheet. The recent announcement that the CEO will resign after 22 years could be the catalyst for a more shareholder friendly management.

    Company overview

    VII designs and manufactures video systems and components used for surveillance and security by governments, corporations, institutions and global transit/commerce hubs. Foreign sales to U.K., Europe, Middle East and Pacific Rim account for ~23% of total sales.

    Source: SEC filings

    All values in millions except per share

    *Includes shares held by Henry Investment Trust managed by board member David Wright

    **Includes cash/equivalents of $4,512,938 + marketable securities (fixed income mutual funds) of $2,386,466 + expected net proceeds from sale of real estate of $2.5 million

    Note: In April 2013 VII sold New York headquarters for $6.35 million for a profit of ~$3.5 million with closing scheduled for August 2013. This property was carried on balance sheet at depreciated cost. As I mentioned in a previous research report on Stratus Properties (NASDAQ:STRS), this sale highlights the significant disconnect between book value of real estate and market value.

    In April 2013 VII purchased new headquarters facility in Edgewood, New York for $3.3 million. The two transactions are expected to generate $2.5 million in cash. Furthermore, VII has ~$4 million of net operating losses to offset gains.

    Investment thesis

    The investment thesis for VII is asset based (rather than earnings). Accordingly, VII should be valued on an absolute basis (rather than relative) for two reasons. First, there are few publicly traded, pure-play video systems companies (most are subsidiaries of larger companies such as Panasonic or are private).

    Source: Bloomberg

    Value catalyst

    The recent announcement that the long-time CEO would be stepping down no later than year-end is an overlooked value catalyst as the new CEO may be more willing to consider shareholder friendly measures such as a leveraged recap and buyback/special dividend.

    VII can certainly afford a significant debt load given the strong balance sheet ($9.4 million in cash and no debt). Furthermore, the favorable financing market provides low cost debt. A leveraged recap is preferable to a takeover in order to avoid excessive change in control payments to management.

    The growing activist shareholder base must be increasingly concerned regarding the continuing operating losses despite the construction rebound, high exec comp and poor stock price performance. Furthermore the lack of shareholder yield in the form of dividend (none) or buyback (still has ~$1 million remaining under 2009 $1.5 million repurchase program despite the fact that any purchases would be accretive given discount to book value) should act as another catalyst to pressure management and the board to maximize shareholder value.

    The below two shareholders are the most likely to engage with management:

    • David Wright (recently joined the board) is president of Henry Investment Trust, which owns 9.3%.
    • Dimensional Fund Advisors (DFA) owns 8.4%. DFA is encouraging strong corporate governance and increasingly working with activist investors. DFA should no longer be considered merely a passive index fund.

    Insiders excluding David Wright only own 17.3% and do not have a large enough position to prevent a coordinated activist campaign.

    Two strategic holders (CBC Co, a Japanese company that has served as lender, product supplier and private label reseller of VII products since 1979 and The InterTech Group, a family-owned holding company) own 22% and are the least likely of any shareholder to sell. Furthermore, Renaissance Technologies owns 5.32%.

    Source: SEC filings

    Despite steep sales declines (30% in mrq) and continuing net losses (mitigated to some extent by cost cutting program initiated in 2H11), VII generated significant free cash flow in the ttm of ~$2.5 million (~$2.8 million operating cash flow and ~$0.3 million capex) due largely to a 41% decrease in accounts receivable in the mrq.

    Risks

    Technical problem. The latest software platform contained a technical problem that negatively affected sales.

    Dependent on construction/economic growth. VII sales have fallen due to slowing worldwide growth (especially in Europe).

    Foreign exchange exposure. Risk managed using forward exchange contracts and shifting product sourcing to suppliers transacting in more stable/favorable currencies.

    Competitive industry. The industry is extremely competitive and requires large capex due to rapid technology changes. VII is one of the smallest competitors. However, as previously stated, the investment thesis is not based on VII gaining market share.

    Conclusion

    Given the significant discount to net tangible assets, positions can be scaled into on any weakness. However a relatively tight stop of 10% should still be used to limit losses. Re-entry is encouraged if stopped out and stock rebounds. A conservative target price is 75% of book value or ~$3.25. The time frame is 12-18 months.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Themes: long-ideas Stocks: VII
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