Description:

Overview:

At just over 4x forward twelve month EBITDA, DDI Corp (DDIC) offers downside protection with a free option on a business that is benefiting from an increasing trend in North American quick-turn business.  One of its main competitors, TTM Inc (TTMI) just acquired a Printed Circuit Board (PCB) company (a comparable company) from Tyco for 7.8x EBITDA - that would value “the new” DDI at $13.  In addition, DDI’s other main competitor, Merix Corp (MERX) acquired an Asian company for 8.5x  EBITDA which would value “the new” DDI at $14.80.  Part of our thesis is that the "quick-turn" portion of the business has a greater value than the increasingly commoditized PCB side of the electronic manufacturing service industry, but using recent PCB type acquisition multiples still emphasizes the opportunity to own DDI at current levels.

 

DDI manufactures Printed Circuit Boards on a quick-turn basis (short lead times – think 24 hours to 7 days).  The company provides time critical solutions to customers such as Qualcom who need a PCB immediately.  Approximately 50% of PCB sales in ’05 were generated from services delivered in 10 days or less (only 20% of total revenue for TTMI and MERX).  DDI serves customers in the Communications / Networking, Medical, Computing, and Military industries.  No customer accounts for more than 5% of the business and the company’s revenues are diversified among thousands of customers. 

 

 

Last month, the company announced the sale of its low margin assembly business for $12 million cash (10X EBITDA) and also announced the purchase of Sovereign Circuits for $14.8 million (part cash and part stock and assumption of $3.3 million of debt).  This acquisition will enable the company to increase its focus for the first time in its history on the higher margin military markets.  Although this acquisition appears to be valued at a little less than 4x trailing EBITDA, it will probably end up being valued at 2x forward EBITDA due to the synergies and the new business that Sovereign has lined up for next year.

 

 

Mikel Williams joined the company in November of 2004 as CFO (Prior to that, he was instrumental in selling one of KKR’s portfolio companies).  He became CEO in November of 2005 and began to implement his turn around plan.  He improved the capital structure through a rights offering that was completed in the third quarter of 2005.  The rights offering enabled all shareholders to participate as opposed to select institutional investors through a PIPE offering.  He divested non-core businesses and started to focus on profitable business.  He has lit a fire under the sales force that had been known in the industry to be very complacent.  Customers went to DDi for their highly regarded engineering, short term production advantages, capacity, and not necessarily because of a particular sales person.

 

 

MERX conf call

“The increased revenue was largely attributed to increased quick turn revenue and premium pricing…”

“Average pricing was up slightly (sequentially)…”

“…we are seeing strength across all of the end markets”

“…it looks like quick turn was up 13% sequentially…”

 

TTMI conf call

“We do not see any inventory builds…we feel pretty optimistic about the balance of the year.”

“July / August timeframe is a little choppy (due to seasonality)…”

 

Obviously, we highlighted the positives about the industry from DDI’s competitors’ recent conference calls.  However, some people did focus on the effects of higher raw materials.  Most thought that they could pass these through to their customers.

 

 

DDi Corp has a 27 year operating history.  The company created the “Time and Technology (Quick Turn)” concept and market.  The company experienced rapid growth in the 1990’s as did most contract manufacturers during the technology boom.  The company expanded both domestically and overseas (Europe) and acquired facilities to meet growing demand.  The company’s IPO through Roberston Stephens could not have been completed at a worse time (for new shareholders) – April of 2000.  However, we all know how this story ends… The company overextended and business dried up.  DDi was left with facilities that were far from breakeven.  The company filed for bankruptcy in August of 2003.  Shortly thereafter, in December of that same year, the company emerged from bankruptcy.  All equity holders were wiped essentially out and the convertible holders ended up owning the company.  Since that time, the company has shut down its European operations and divested all non-core operations.  But the exciting part comes in now, as DDi is about to embark on a new beginning as its focus is solely on core PCB engineering and manufacturing.

 

 

Increasing customer demand for quick-turn production and integrated solutions. Rapid advances in technology are significantly shortening product life-cycles and placing increased pressure on original equipment manufacturers to develop new products in shorter periods of time. In response to these pressures, original equipment manufacturers look to printed circuit board manufacturers that can offer design and engineering support and quick-turn manufacturing and assembly services to reduce time to market.

 

Increasing complexity of electronic equipment. Original equipment manufacturers are continually designing more complex and higher performance electronic equipment, which requires sophisticated printed circuit boards that accommodate higher speeds and frequencies and increased component densities and operating temperatures. In turn, original equipment manufacturers rely on printed circuit board manufacturers that can provide advanced engineering and manufacturing services early in the new product development cycle.

 

Shifting of high volume production to Asia. Asian based manufacturers of printed circuit boards are capitalizing on their lower labor costs and are increasing their production and market share of printed circuit boards used, for example, in high-volume consumer electronics applications, such as personal computers and cell phones. Asian based manufacturers have been generally unable to meet the lead time requirements for the production of complex printed circuit boards on a quick-turn basis.

 

 

The following table shows the company’s operating results prior to the recently announced transactions.

 

 

 

 

Market Cap =                        $177 million (Fully Diluted + Shares Issued for Sovereign Acq)

Enterprise Value =                  $171 million

 

Cash:                                      $21.5 million

Debt:                                      $13 million (Line of Credit, GE, + Sovereign Debt)

Net Cash:                               $ 6 million

 

Sales (TTM):                         $185 million

EBITDA (TTM):                   $20.1 million

EBITDA Margin:                   11%

 

EV / EBITDA (TTM) = $171 / $20 = 8.5x

 

Capex is approx $4.4 million annualized.

 

Now we will make some assumptions to estimate the following 12 months as it relates to the “new” company.  The current run rate on a pro-forma basis for the sale of assembly and the acquisition of Sovereign is $7 - $8 million EBITDA per quarter before bonuses for 2006.  Let’s assume that the company grows revenue by $5 million per quarter next year ($20 million annually) at 40 percent incremental margins.  This adds $8 million in EBITDA to the current $32 million run rate for a total of $40 million in EBITDA.  This equates to 4x EV/EBITDA.  Keep in mind, a strategic acquirer could reduce approximately $15 million of duplicative costs making this a very compelling acquisition candidate.

 

 

 

TTMI Inc (TTMI)

Merix (MERX)

 

 

You may be reading this and asking yourself how does this business and scale and why isn’t it vulnerable to the standard risks associated with off-shoring.  The answer to these questions is the reason that barriers to entry exist in this business.  For example, the Jabil’s, Sanmina’s and other large contract manufacturers are focused on long-run, high volume jobs.  DDI’s focus is on high margin, short-run projects that entails tremendous focus and engineering capabilities which are nearly impossible to commoditize.  Also, the military market is least vulnerable to foreign competition as the US government requires work to be done domestically.  In addition, computer and telecom along with semi companies have extensive requirements for product development and prototype support for next generation products that need to be completed immediately.  Think about it this way:  Suppose you are Qualcomm and you are testing a new design.   Lets say you need to make a change.  Do you send the specs to China and wait 4 weeks to get the boards back or do you pay up a bit and submit the work to DDI and get the results immediately. 

 

 

End market weakness

Slowing economy

 

Expanding Military Market presence through recent Sovereign acquisition

Potential take out

Q4 should be very strong – Acquisition integration benefits should be apparent

Potential analyst coverage

 

 

Disclosure:  We own shares of DDIC and may buy or sell shares at any time.