Modeling ADDvantage Technologies' Runoff Value

About: ADDvantage Technologies Group, Inc. (AEY)
by: Silky Oak Capital

Significant free cash flow despite lack of earnings.

Nave segment is hiding earning power of other two segments.

Even a pessimistic run-off scenario still makes this a double.

Market probably gives too little credit for inventory.

I wrote an article about ADDvantage's (NASDAQ:AEY) hidden real estate assets that could be worth $15 million. But they also have intangible assets they can use to shield against taxes. My estimate is that this is roughly $1.3 million a year going by the latest 10-Q. This has to do with their acquisitions, which came with customer lists. This is not a real economic charge.

Additionally, they have three segments, Nave, Cable and Triton. The Cable and Triton Segment are very profitable. Triton actually generates about $1.7 million in EBIT and growing. And the Cable segment seems to generate between $1.5-2 million in EBITA a year. They are slowly becoming the last and largest player in the cable business, so this might be sustainable for some years to come as well.

Since it is not very useful to value this business based on a earnings multiple I created some models of what a run-off scenario would look like. I assumed $10 million in additional inventory write-downs (beyond their usual inventory write down provisions) and it looks something like this (click to enlarge):

If the run-off earnings of Triton are valued at 5x EBITA, then that implies a value of about $36 million for the whole business. Do note that the business would barely generate any profits over the next decade, and I assumed they can sell $5 million of real estate on the books for about $8 million after year 10. Previously I estimated their real estate value between $7-$15 million. So assuming they get only $8 million after 10 years is not very optimistic.

I think this is a pretty pessimistic outcome since Nave will not generate significant profits before being written off basically and Cable will go to zero. Their cable segment might actually be around for a long time. I also assumed no growth in Triton segment, and clearly this business was growing last year.

A more optimistic scenario might look like this (click to enlarge):

Here I assumed all segments do slightly better, and Cable segment actually has some run off value after 10 years. I assumed only $6 million in additional inventory write-offs, and assume they sell $3 million worth of real estate on the books for $4 million.

If the remaining earnings of both Cable and Triton are valued at 6x EBITA, total value is roughly $45 million. Or 200% upside from current price. The $7 million of inventory is included in the remaining value of the two businesses (or 6x $1.8 million). And this is without making overly rosy assumptions. Assuming that their Nave acquisition is pretty much a dud, but their Triton acquisition is actually a success.

Add in some well timed buybacks in the mix, or another Triton and you get more, add in another dud acquisition like Nave and you get less. But given that the two brothers running this business (who own about 27% together) are over 70-years-old, I think it is more likely the business is either sold or liquidated at some point in the future.

As for a Nave earnings recovery, this is heavily tied to capex spending of major telecom firms. It is expected that mobile data usage will grow very rapidly in the next decade. So it is likely that Telecom companies will have to ramp up their capex spending at some point. This will be beneficial to especially their Nave segment. So this could mean free cash flow from Nave alone could be $3-5 million if the cycle really turns.

Obviously if they have to do major write downs of their inventory this stock will not do well, but as you can see there is a pretty large margin of safety. And according to management some of their cable inventory (which is the majority of their inventory) is up to 15 years old:

We have everything from brand new in the box to subset literally can be 15 years old to service our industry. Because literally we have players in our industry that needs stuff that’s 15 years old to replace but then they also have things that are brand new out of the box.

If they had brand-new equipment, and selling it quickly was crucial, I would be more worried about inventory becoming obsolete. But that does not seem a major risk here. Also inventory write downs in the past have been very modest so far for their Cable segment especially.

So to sum it all up, I think this stock is too cheap, with a wide range of outcomes. And most of those outcomes will probably lead to a higher share price. Especially if they turn their currently money bleeding Nave segment around.

Disclosure: I am/we are long AEY. 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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