DISCLAIMER: This is a thinly traded microcap (nanocap?) with limited float. Insiders own nearly 50% of the outstanding stock, meaning float is around $11 million. However there had been good volume available at least up until a couple of weeks ago, and it seems there is some interest in the name judging from the last time it was posted on this board. So with that warning out of the way, here goes.

Summary

Addvantage Technologies is a cable equipment distributor trading at 61% of tangible book value, 79% of net current asset value, 6x trailing (trough?) operating income, and 1.5x peak operating income. The company has never lost money. The company is run by two brothers in Oklahoma who bought the company out of bankruptcy in 1985 and over time built it into what it is today. The brothers still own approximately 50% of the outstanding stock, so they are heavily incentivized to create value, and they have treated minority shareholders fairly in the past. The company is in a strong financial position, with $0.35 per share of net cash and plenty of assets to borrow against. If the stock price does not recover on its own in the next couple of years, I see a high likelihood that the company eventually goes private or returns significant cash to shareholders. I see fair value at a small premium to tangible book, about $4-$5 per share.

History

The company went public via reverse merger in 1999 which resulted in the brothers owning 80% of the combined company, and the company owing $20 million to the brothers in the form of preferred stock. Fast forward 13 years, and the company was grown book value from -$8.1 million to $37.8 million purely through retained earnings, in the process paying off all debt and preferred stock. The brothers still own about 50% today, having sold off some several years ago when the stock was trading at a high price and then having bought some back when the stock was cheap in 2009.

Business

Stepping back a bit, what exactly does the company do? Addvantage is a stocking distributor of cable equipment. There are cable equipment manufacturers – historically the biggest ones have been General Instrument (which was sold to Motorola which was sold to Google which in turn sold it a few weeks ago to Arris) and Scientific-Atlanta (which is now part of Cisco), but there are other big ones including Arris (now even bigger) and some others. Then you have the cable MSOs who buy the equipment in the course of upgrading or wiring new subdivisions or replacing damaged equipment.

Normally equipment doesn’t pass through distributors – Comcast will place an order with Cisco, Cisco will manufacture it for them and deliver it three months later. But it doesn’t always work this way. Sometimes the buyer doesn’t have that kind of lead time, whether due to poor planning, or natural disaster, so they pay a premium to get it NOW. Also, AEY facilitates the trade of used equipment – when an MSO upgrades, they sell their used equipment to the likes of AEY, who refurbishes it and sells it on to less technologically advanced MSOs or maybe even out of the country. Besides selling to MSOs, AEY also sells to other distributors who don’t hold inventory. Finally, AEY has a small business repairing equipment.

All told, management believes there are 10-12 other players, most or all of which are smaller. (You can find them via Google search, if you are so inclined). AEY itself actually does business under four separate names, each of which distributes product from a different manufacturer. One brother runs the business which distributes Cisco product and the other runs the business that sells Motorola product.

The cable equipment distribution business is neither a terrible business nor a great business, but management has run it well over the years. Gross margins are high (30%), but inventory turnover is low, so returns on invested capital are decent. After-tax return on invested capital has ranged from a high of 20% (in 2007) to a low of 6% (in 2012). This translates into a nice ROE with the application of leverage (until last year, AEY had consistently been in a net debt position). In its history as a public company, AEY has never lost money.

The stock is cheap because earnings are declining. Earnings are declining for two reasons:

-        The housing bust and the end of the last upgrade cycle. They kind of hit at the same time. When people start building new subdivisions and upgrading to IPTV, earnings will grow again. I can’t say when that is, however.

-        A change in their relationship with Scientific-Atlanta. A few years after buying S-A, Cisco realigned to sell to one master stocking distributor (not AEY) instead of several. The good news is that means AEY no longer has to invest in inventory of new Cisco product. The bad news is that a big chunk of revenue and profit went away. The effect of this mostly went through last year.

Based on the above, I think earnings are bottoming out this year. I think it’s possible based on the above that profitability never gets back to where it was at the peak, and indeed the last decade may have been an anomaly, but even an ROIC of 6% with some leverage translates into a very nice ROE.

Next Steps

Where does the company go from here? The company is virtually debt free, with $3.5 million in net cash and a $7 million untapped credit line vs. a market cap of $22 million and a float of $11 million. The company has over $35 million in tangible assets excluding cash, including $7 million in real estate and $23 million in inventory.

On past calls, the company has said they see acquisitions as the best use of capital (I know, *groan*). But the company has a good history with acquisitions, having done 7 in total since they have been public for a total cost of $9 million. Based on public disclosures, for the most part they have avoided paying over tangible book value, and they seem to have generally worked out fairly well. Also, they have been looking for a couple of years without really finding anything, which suggests they are disciplined, if nothing else.

The company has also said on past calls that over the years they have looked at going private or doing a dutch tender. They haven’t really bought back much stock on the open market because of the limited trading volume (they did buy back 2% in a private transaction in 2008). I don’t think a sale is on the horizon because there isn’t an obvious buyer (as far as I know). I think another option that they haven’t really talked about is going dark, which would save a non-trivial amount on public company costs.

In my opinion, any of the above moves would be a catalyst to drive the stock higher. I don’t think this is a situation where entrenched management is trying to bleed minority shareholders; indeed, almost every earnings call has included some discussion of strategic options.

Key Financials

Income Statement & Balance Sheet (Fiscal Year ended September 30)

Valuation Summary:

Stock Price: $2.17

Diluted Shares Outstanding: 10,190

Market Cap: $22,111

Net Cash: 3,505

Enterprise Value: $18,606

Tangible Book Value: $36,256 ($3.56 per share)

Net Current Asset Value: $28,151 ($2.76 per share)