Asset Sales At Video Display Should Narrow The Disconnect Between Book And Market Value

| About: Video Display (VIDE)
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Key takeaways

  • Video Display (NASDAQ:VIDE) is a classic balance sheet play as the proceeds from the recent sale of a subsidiary highlight the value to be unlocked from additional asset sales.
  • The sale proceeds were used to eliminate net debt, which reduces the risk of any further delay for the sale of two additional subsidiaries.
  • The improving outlook for the remaining subsidiaries should result in a higher sale price if management continues this disposition strategy or a higher valuation for the smaller but more focused company if not.
  • Insiders have a significant incentive to pursue the strategy that maximizes shareholder value given that they have the most to gain (and lose) with 74% ownership.

Company overview

VIDE manufactures and distributes displays and components used in a variety of applications. The two operating segments include the following:

The monitors segment provides a range of cathode ray tube displays (NYSE:CRT), flat panel and projection display systems for use in training and simulation, military, medical and industrial applications.

The data display CRT segment provides a range of CRTs used in data display screens including computer terminal monitors and medical monitoring equipment.

One sale complete - two to go...

VIDE made significant progress in the past year (through the below four steps) towards maximizing shareholder value by following through on its stated intention to sell all or part of the company.

First, in November 2013 VIDE entered into a written agreement to sell its Z-AXIS subsidiary. The initial closing date (11/15/2013) was postponed due to delays in obtaining the necessary government agency approvals although this transaction should have closed by the end of December 2013*. Once this sale is complete, the cash balance should increase to >$10 million.

Second, in August 2013 its Aydin Displays subsidiary was sold to Sparton Corp. for $15 million (combination of cash and $6.6 million potential earn-out based on subsequent 12-month EBITDA) for a gain of $2.9 million (excluding the earn-out). The proceeds were used to completely repay its line of credit and one term loan as well as reduce the balance on a second term loan from $3.6 million to $1.35 million. The interest rate on the remaining loan was reduced 400 basis points to 5%, regular principal payments and covenants were suspended and the maturity date was extended. Moreover, VIDE no longer has to pay ~$2,000 per day in penalties.

The swing from a large debt load to a small net cash position in such a short time frame cannot be emphasized enough for three reasons. First, the stronger balance sheet provides more "breathing room" as it transitions from providing CRTs to newer display technologies. Second, the fact that VIDE was able to work with its lenders despite being in default due to non-compliance with covenants should not be taken for granted. Third, the significant cash interest savings (e.g. VIDE paid $774,000 in the past six months alone) drops straight to the bottom line. Management said in the most recent shareholder letter that the balance sheet is in the strongest condition of its 38 year history as debt declined from ~$28 million while the cash balance is ~$2 million.

Third, in July 2013 VIDE signed a definitive agreement to sell its Lexel Imaging Systems subsidiary to Citidal Partners. However, this transaction initially expected to close on or before 9/23/13 has not closed due to financing delays.

Fourth, in February 2013 VIDE closed its Novatron facility in Louisiana and Southwest Vacuum Systems and moved the remaining inventory and operations to its other subsidiaries. The Louisiana property was subsequently sold for $400,000.

*Management said in the shareholder letter (dated 11/26/13) that there was a proposed closing date within the next 30 days. To my knowledge, this sale has not been completed.

...while implied value for remaining assets is lower than market value

After the previously mentioned sales, VIDE will be a smaller and more focused company with minimal capex requirements and strong growth prospects. Moreover, VIDE has a competitive advantage due to its ability to engineer custom displays, provide internally produced components and handle low volume orders with higher margins. Furthermore, it competes in niche markets with less competition from larger electronics companies.

The remaining subsidiaries (includes Lexel Imaging as it appears this sale is less likely to close in the near term than the sale of Z-Axis) are below:

  • Lexel Imaging provides special purpose CRTs and displays used in a range of military and commercial applications including photorecording, X-Rays, tank thermal viewers, cockpit displays, flight simulation and heads up displays (NYSE:HUD). In the most recent six month period sales rose 25.8%.
  • VDC Display Systems provides display systems used in a range of commercial and military applications (such as drones) with a focus on training and simulation. In the most recent six month period sales rose 20.3%. In November 2013, it was selected as a supplier for the U.S. Army Common Driver Training.
  • Ayon Visual Solutions (AVS) distributes command and control visualization products. AVS (started in July 2011) generated >$1 million in sales in the most recent six month period and management expects to more than double that in the upcoming quarter alone.
  • Ayon CyberSecurity provides electronics for cyber security markets. This is the weakest of the remaining divisions as sales declined 9.2% in the most recent six month period while gross margins are currently negative. However management said it is "turning the corner" and is working to lower the cost structure.

As a result of the Aydin Displays sale (and assumption that the Z-Axis sale will close), management provided revised guidance. In FY14, it projects diluted EPS of $0.14-0.16 on revenue of $40-42 million. However for FY15, diluted EPS is projected to be $0.44-0.48 on revenue of $38-40 million. As a result, VIDE trades at only 8x 2015 EPS (using midpoint) with the possibility of additional asset sales generating significant proceeds that could be used to reward shareholders via a special dividend or buyback*.

*The restriction limiting buybacks to 10% of net earnings after taxes should go away if/when VIDE repays the remaining small amount of debt.

Valuation and catalysts

The below chart (provided in the shareholder letter) highlights the asymmetric opportunity. As shown below, the value of the sale of all company assets in the worst case scenario is above the current book value.

This opportunity only exists due to the uncertainty surrounding the sale of Z-Axis and Lexel Imaging, which results in a lower implied chance that any or all of the remaining subsidiaries will be sold. Even after one of the sales closes, the market should begin to re-price in these sales. However, waiting for increased visibility regarding these sales is not advisable as the market does not reward those unwilling to take risks.

Risks

Below are the primary risks to the investment thesis, in order of importance:

  • Pending and/or remaining asset sales may not be completed or the price may be below management estimates.
  • The demand for replacement CRTs and component parts continues to decline as a result of the shift to flat panels, where the competition is intense and increasing. The risk of inventory write-offs (due to slow moving inventory as the replacement market develops over 5-7 years) is mitigated as VIDE discontinued last time buys and reduced inventory in continuing operations by $1.3 million in the most recent six month period.
  • A decrease in defense spending would negatively affect results given the increased reliance on military spending.

Conclusion

The target price of $4.38 is based on a 10% premium to the previously mentioned worst case asset sale scenario. Given the volatile trading range over the past six months, a stop should be placed below the recent support at ~$3.30 or ~11% below the current price with a smaller position size to compensate for the higher risk (unless you are willing to assume this risk). The time frame is one year as the two pending sales should close within this time frame. If these sales (or new ones) are not completed in this time frame, consider the investment thesis invalidated, which would require exiting the position and re-evaluating.

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.