Description

Deswell Industries (NASDAQ:DSWL) is a Hong-Kong based contract manufacturer, operating primarily in
plastic injection molding and electronics assembly. I expect total returns
over the next 5 years to be somewhere between a REIT and a rocket ship. Let's
look at the REIT case first:

Deswell payed $0.88 cents in dividends over the past 12 months. At the
current price of 17, that's roughly a 5% dividend. We can estimate
their long run earnings growth as (retained earings * return on assets)/TTM earnings
((2.02 - 0.88)/2.02 = %9.6,

so we can look forward to a "growth reit"-like %14.5 total return,
with roughly a third coming in dividends. It's true that there's
political risk with Deswell, but it is offset somewhat by Deswells
balance sheet ($5.55/share in cash, no debt), and may be no more than
the interest-rate/debt/real-estate-cycle risks that one assumes
when buying REITS. Deswell could in fact decrease portfolio risk
for a US-based income-oriented investor; it doesn't seem to correlate
well with anything.

So far, so good, but not very exciting. But there's more!

1: Deswell's TTM earnings have been depressed by the
Asian crisis (Deswell's business lags; they were reporting record
earnings when the rest of Asia was collapsing), and by the loss
of a major customer at the electronics assembly sub. I think that
they will make $2.40-$2.50 on a forward basis, as plastics contracts
pick up and the electronics sub replaces the lost business.

2: I think their 5 year growth rate will be much higher
than %9.6. I estimated using ROA above, to be conservative; but
return on equity is probably a better measure. ROE for the last
5 years has been:
2000 %20
1999 %23
1998 %36
1997 %37
1996 %34
Yeah, it looks bad because ROE is declining; but if they can get
back to anywhere pre-Asian crisis levels, (say, %27), then earnings
growth jumps to %17 a year.

3: As I noted above, about 1/3 of Deswell's assets are in
cash; in their most recent quarter, about $5.55 per share. What if
they could actually deploy some of that cash? Let's take a look
at their return on plant/property equipment for 1998, their last
good year: Property/Plant/Equipment - Depreciation =15.6 million,
earnings = 13 million, for a roughly %80 return on sunk costs.
And there is evidence that they are investing in plant: since
February, they've announced investments totaling $11 million
in new plant and equipment.

In general, Deswell's management seems to be at least competent,
although perhaps too conservative. On a macro level, demand for
their services should be fairly strong, given their quality level
and low labor costs; or, if demand isn't, it's time to short the
QQQ. I don't have enough insight into the industry to guess about
the supply picture. My assumption is that Deswell will face generally
lower prices, but hold margins at least steady through economies of
scale, and moving up the food chain.
The company doesn't seem to be a scam; if it is, it's
one of those really deep scams that involve no insider-selling,
no puff press-releases, and sending dividend checks to strangers
in foreign countries -- a scam so deep, that I want to get in early.

Deswell has seen a bit of a run-up lately, about %20 over
the last 3 months. I liked them better around 15, where I thought
they were a steal; but some might think them attractive at the
current price, and the stock is volatile enough that there could
be a chance to pick it up more cheaply.

Risk Factors:
1: "Asian micro-cap"
2: >50% insider owned; no institutional investors to speak of.
3: The plastics division consumes oil. They have hedged this
in the past, but may not be able to in the future.
4: I don't understand how the are able to maintain margins > %17,
let alone the >%25 margins they used to have.
5: Highly illiquid; you might not just move the market, you might _be_
the market.
6: I belive that michael99, a poster here, was a holder but then dumped them.
He may know some dark secret.

Summary:
Deswell is a cheap and ignored Asian micro-cap. If their
business returns to something like its pre-Asian-crisis
levels, they should grow rapidly; if not, they're not a
a bad income investment.

Catalyst

Nice yield, recovery from Asian crisis & loss of a major customer,
high-return capital expenditures.