As a net-net investor I have seen a number of extremely undervalued stocks and have grown a thick skin when it comes to putting my money in companies with bleak prospects. Most companies I invest in have two things in common: they trade under net current assets and they are in deep trouble. So obviously my approach as investor is not based on finding the best companies but on finding the best (i.e. the cheapest) among the worst.
STR Holding represents an unconventional and extreme case even within my rather atypical net-net portfolio. To start with the company trades in the OTC markets, which I generally avoid for a number of reasons. So why would I do an exception? first of all, unlike most net-net companies trading in the pink sheets, STRI has a long history/reputation behind, a straightforward business and no indication of it being a scam. The fact that my email to investor relationships was swiftly answered with a kind request to arrange a telephone conversation with the CEO Bob Yorgensen, with whom I maintained a friendly and interesting discussion before writing this article, only reinforced my impression that STRI still remains a trustworthy company. But most importantly, the company is extremely undervalued and is trading at multiples which I have literally never seen before with the sole exception of stocks which were undergoing bankruptcy proceedings or were suspected to be scams. Of course this extreme undervaluation comes as a result of a number of serious issues. To put it in few words, the company went from being a relevant market player in a growing industry (solar panels) to being a serial underperformer with permanently decreasing revenues in a low margin business of a lagging industry.
Five years ago the company's revenues were 232 million and the solar industry had a brilliant future, currently STRI is struggling to reach revenues of 30 million, having lost many of its most important costumers such as First Solar. For several years now the company has been trying to find solutions its perennial stagnating revenues. In 2014 STR Holdings partnered with Zhenfa Energy Group, a privately held Chinese developer of solar power stations. The agreement was rather promising for the stockholders of STRI: Zhenfa agreed to buy a 51% stake of STRI for an aggregate of 21.7 million USD (1.60 USD/Share, a 23% premium over the share price back then, 1.30 USD). The idea was to move production and business away from lagging solar markets in the west to the growing industry in China. Zhenfa would bring in the contacts and costumers and even agreed to provide manufacturing facilities at zero cost for a period of 5 years. Stockholders received a special dividend of 0.85 USD/Share as a result of this transaction, which was followed by a 1:3 reverse split to ensure compliance with listing requirements.
But the story did not quite go as STRI had hoped. Revenues in the USA and Europe continued to decline while business in China, even with a Chinese partner, proved more challenging than expected. Fierce competition forced STRI to reduce their prices and the long processes of qualification for each new costumer slowed down the much needed growth in revenues in China, which fell short of compensating for the declines elsewhere. On top of that, payment delays when not outright defaults, more common in China than in western economies, did not contribute to making a smooth return to profitability.
Upon reaching the agreement, STRI was trading roughly around net cash on hand (cash and equivalents minus total liabilities), which under normal circumstances represents a rather low valuation even when the company is losing money and the expectations are running low. During 2015, as investors became aware of the challenges in Chinese markets, the share price tanked even further under net cash on hand. In September 2015, with shares trading under 1 USD and a Market Cap under 15 million USD, the company was delisted from the NYSE and moved into the OTC market. The delisting brought the price further down to 50 cents, which back then (and even today) seemed like an outrageously low valuation. In the last 12 months the company has essentially been left for dead, currently trading within a range between 15 and 30 cents.
While, as already explained, the company is in deep trouble, share price has reached a level which could only be justified if bankruptcy was just around the corner (which is not). For conventional value investors (let alone growth ones), it is difficult to grasp the degree of undervaluation which the current share price entails.
Behind the losses and the stagnating revenues, STRI has managed to maintain a healthy balance sheet. But it is not the balance sheet as such which is impressive, but rather the ratio of net asset to market cap. To provide a short summary: the company has 23.5 million USD or 1.27 USD/Share in net current assets (current assets minus total liabilities), representing more than 5.5 times current share price of 0.23 USD. But this is not all, the company also has over 16 million USD in real estate assets (i.e. factories), bringing the tangible book value per share to 2.15 USD, more than 9 times current share price.
When making bull cases for net-net companies I have often been confronted with the argument that the market price under net assets was justified because the remaining cash and assets were dead money which would be swept away sooner or later. Indeed, investing on balance sheet ratios implies considering the current reality of the company rather than its future prospects. This is both the main strength and the main weakness of this investing approach. It is a strength because we humans, and in particular investors, are generally awful predictors and even worse assessing our predictive skills (even with hindsight). But it is also a weakness because, in the long run, an investment is only worth what the company will manage to produce in the future. In order to bring in the future prospects into my analysis without deceiving myself pretending that I know what the future will bring, I generally draft three different scenarios (worst/likely/best) and compare each one of them with the current share price. You will forgive me if I remain vague when it comes to probabilities and numbers and stick to expressions such as "likely", "unlikely", "much more" or "much less". Although this is as far as I well get when it comes to assessing the future, the good news, and in fact one of the keys to deep value investments, is that the more extreme a valuation is the less we need to be precise or concrete in your predictions. This is what the master Benjamin Graham called "margin of safety".
Let us first consider the worst case scenario: everything stays the same, nothing happens and the company continues burning its assets quarter after quarter. In the first semester of 2016 the company actually increased its cash reserves due to a tax refund of 8.3 million USD (yes, almost twice current market cap), but disregarding this one time issue, the company burnt 2.4 million USD. This represents a 35 % decrease in cash burn versus the first semester of 2015. Conservatively assuming the same cash burn rate, it would take the company 5 years to burn all of its current assets. Even then, the company would still have 16 million USD in fixed assets, which at a conservative 50% discount, would still bring around 43 cents per share, almost twice the current market price. Unless, of course, the company decided to sell all of its fixed assets and continue to burn through all the resulting money. Not that this could not happen, but it seems unlikely that the company would sell its factories and continue operations at the same time.
The best case scenario would imply the company becoming profitable again. While this is unlikely to happen in the near term, the fact is that revenues appear to have bottomed in the last quarters. Looking at the ER of the second quarter of 2016, for the first time in many years, STRI managed to increase its revenues sequentially versus the previous quarter. The sequential increase was primarily driven by a 127% year-over-year increase in revenues from China and India during the first semester of 2016. Since most of the revenues come now from these growing markets (62% to be precise), I expect revenues in the third quarter of 2016 to increase both sequentially versus the second quarter and year-over-year versus the third quarter of 2015 for the first time. Whether China and India will continue to deliver exponential growth is, at this stage, unclear. It is also unclear whether, given the low margins in these markets, growth would even suffice to attain profitability again. Nonetheless, since the qualification processes appear to be ongoing for a number of costumers, revenues should continue to climb at least for the next quarters. It should however be pointed out that both cash collection and pricing in these growth markets are far from being ideal for STRI. Still, it is obvious that the situation in terms of growth is far better than the share price reflects. Needless to say, should the company come even close to turning a profit, the share price would be multiples of what it is now (I do not even dare to give a number here).
Let us finish with what I consider to be the most likely scenario in the short and mid-term: the company continue to report losses while trying to pursue strategic alternatives. Here I am not even being very imaginative, since STRI has already given explicit hints in its ER notes that it will try to make use of its excess cash to create shareholder value with strategic alternatives. Therefore, rather than a question of whether this will happen, this is a question of when and how it will happen. At this point I would like to return to the balance sheet in connection with the recent history of STRI: after closing down its Malaysia facility last year, STRI put their manufacturing venue on sale. According to the last ER they received and accepted an offer of 6.3 million USD, so it can be expected that this amount will be added to the cash balance in the near future. Since the search for strategic alternatives has been going on for a while, I believe the company might already have some concrete plans on the table. The imminent sale of the facility in Malaysia could become the triggering event for the long awaited turnaround, and I would not be surprised if the announcement of strategic action came along or right after the announcement of that sale.
But what kind of strategic action are we dealing with here? At this stage, and despite the low valuation, I believe share buyback programs and special dividends are not on top of the list. Such alternatives might sound as the most attractive in the short term, but given the small numbers with which we are dealing here, the costs would eat away much of the profit for shareholders. Instead the company will likely acquire assets in more profitable sectors, probably in downstream solar sectors and/or in any other sector in which they could profit from their unused capacity in their Spanish facilities (e.g. plastic sector). Furthermore, in view of the challenges STRI is facing in China and the difficulties to repatriate cash from that area, I would bet that the company is targeting assets in other countries.
All in all, we have a company trading at the lowest Market Cap/Net Current Assets ratio that you can find in the market, with a growing (if challenging) presence in China and India, with increasing revenues going forward and about to announce a strategic acquisition. Surely this all comes at a price: very high risk, low margin sector, OTC markets, extremely illiquid stock and huge spreads… so not an investment that big players could consider or that inexperienced investors should consider. However, as a small unconventional position for fairly experienced deep (very deep) value investors, in particular for net-net investors as myself, it does not get much better than this.
Disclosure: I am/we are long STRI.
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.
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