Description

LGL Group's board of directors chaired by Marc Gabelli, who with his father Mario owns about half of the company, has approved the spin off of their only operating company,  MTronPTI, likely in Q1 2022.  The separation of MTron will leave LGL Group with no operating company, but about $3.90 a share in cash/treasuries and $5.75 a share in newly public IronNet shares (at $10.92 closing price and using 5.4 million LGL shares).  These were earned by sponsoring the SPAC (except for $2.7 million worth purchased in the PIPE) that took IronNet public on August 26th and do not yet appear in reported financials.  The board believes separating the two companies will result in higher valuations than together.  I concur, and expect the separtion to highlight the assets on the balance sheet resulting in a total valuation significantly higher than the $12.72 current share price.  Indeed, MTron has a history of growth, interrupted only by Covid, that will soon resume.  Their specialty areas including electronics for military radio communciations, electronic warfare, radar, satellite communications, and missile navigation have grown in recent years.  They'll contine to grow as humans in $100 million fighter jets are replaced by smaller, less expensive, and more numerous robots on earth and in the air, sea, and space.  I will argue MTron by itself may be worth $12 or $13.  Furthermore, the spin of MTron will create a shell company likely to be used to acquire a private company from among candidates already identified during the IronNet SPAC search.  Gabelli may be able to create a few dollars a share in additional value by using LGL Group's NYSE-American listing to take a private company public quickly, similar to SPAC transactions or reverse mergers.  A combined stock price in the mid $20's is possible following the spin transaction and a private company acquisition paid for with cash, possibly liquidated IronNet shares, and LGL Group stock.

European style warrants were dividended to LGL Group shareholders, one warrant for each common share owned, in November 2020.  Five of these warrants and $12.50 entitle holders to purchase a share of LGL Group (and a share of MTronPTI after the spin) only on their expiration date, November 16th 2025.  If the underlying securities' trading price exceeds $17.50 for 30 days, the European style warrants convert to American style allowing exercise on any date up to expiration.  The warrants offer leverage (last trade price of 75 cents with intrinsic value of $2.50 at $25 underlying security price, for example) to benefit from the coming transactions as well as four years of remaining time value on the growth of MTron and any acquired company.  The warrants are thinly traded, however, and a purchase of LGL Group common itself that trades about $250K per day on average offers satisfactory return possibilities.

LGL Group, owned and controlled by the Gabelli's since the 1990's, was once a much larger company.  They made electronics for wireless communications.  Asian competition made these components into commodities and the wireless business has been wound down to immaterial.  Their military electronics business, MTron, is a good business with proven product reliability and performance in harsh temperatures and harsh vibration critical to customers limiting new entrants.  Military contractors buy from preferred suppliers and MTron is a preferred supplier with a long history at all the major defense companies.  As the wireless product business declined, MTronPTI grew from a small base.  Fiscal 2017 revenues ran $22.4 million with a 3.9% ebitda margin.  Fiscal 2020 revenues were $31.9 million with a 13.8% ebitda margin.  Fiscal 2021 revenues were down slightly to $31.6 million with just 6.8% ebitda margins as growth in space electronics couldn't quite offset the sharp decline in sales to commercial avionics markets.  Extraordinary costs temporarily relocating production back to the USA from their low-cost, high skill India manufacturing facility that was shut down by government order due to Covid hurt margins.  The growth since 2017 has come from taking share of their defense customers.  They've achieved this by hiring engineers adding new capabilities like systems expertise.  LGL no longer primarily sells components for their defense customers to engineer into products.  Rather, they increasingly engineer and manufacture entire subsystems themselves.  This gets LGL more of the business as they engineer in more of their own or partners components.  LGL also enjoys higher product margins to compensate for the systems engineering assistance to their defense contractors.

The nature of LGL's growth, winning greater share of the customer, results in increasing market share for years to come.  The subsystems they engineer are typically in production for eight to ten years.  The customer share they took three years ago resulted perhaps in a single additional product in the first year.  In the second year, they added another new product while the first one remained in production.  In the third year, another new product is added while the prior two year's products remain in production.  It takes eight to ten years for a customer share win to be fully reflected in market share.  The growth from winning subsystems business three years ago has years to go yet!  Encouraging is that in 2021, LGL Group sold their first microwave frequency assembly.  Microwave frequency communications are used for data transmission from satellites to terrestrial assets like autonomous trucks, drones, boats etcetera.  This is growing as low earth orbit (LEO) satellites similar to Elon Musks Starlink network for internet access offer the military low-latency (because the satellites are low) data communications to assets anywhere in the world.  It appears with the first microwave assembly that LGL has won microwave subsytem customer share that should result in growth for years to come.  LGL Group has factories in Orlando and South Dakota that were emptied out as their wireless business declined.  They are only about half full now, so LGL Group can grow for a long time before they run out of space which should give increased leverage to the bottom line.

The only publicly-traded comparable to LGL Group is Frequency Electronics (FEIM) with a $92 million market cap on sales of $54.3 million.  The company has been unprofitable for years until finally reaching slightly above break even in Fiscal 2021.  Gross margins run 31% compared to LGL Group's that typically run in the high 30's with the most recent quarter reaching 39.7%.  FEIM trades at an enterprise value/ revenue multiple of 1.53.  I would argue that higher margin and higher growth MTron might trade at 2.0 times trailing sales or roughly $12 a share.  Two times revenue implies 14.5 times ebitda when their margins return to the 13.8% achieved in fiscal 2020.  That's not cheap, but this is a growth stock with temporarily depressed revenue because of the Covid effects on the commercial avionics market.  Further, the financials have leverage to the bottom line from greater utilization of their half-empty factories that should result in ebitda margins above 13.8%.  Fiscal 2022 sales have remained weak as commercial avionics orders have returned but aren't yet being delivered.  Bookings of $7.8 million exceeded revenues of $6.9 million in the most recent quarter.  Comments from management in the latest report are encouraging.

The company's president and chief executive officer, Mike Ferrantino said "I am optimistic as our markets are starting to show improvement and we our beginning to benefit from our strategic and operational initiatives."

Bill Drafts, president and chief executive officer of LGL's main operating unit, MTronPTI, stated "While the avionics market continued to impact our results, we continue to grow our space business and delivered our first integrated microwave assembly to a top tier defense firm, gaining market share and broadening our technical capabilities and product offering."

RISKS:  IronNet came public as a SPAC at $10 and last closed at $10.91.  I'm sure you're worried that this stock could fall like many SPACs and the $5.75 per LGL Group share could cut in half.  Of course this is a concern.  However, this SPAC deal was done as a partnership between Gabelli, Bob LaPenta, former ceo of L-3 Communications, and LaPenta's son.  Gabelli and LaPenta are capable, reputable people that didn't do a sham deal.  In fact, IronNet seems to be benefitting from the ransomware attacks this year that happened after the deal was consumated. IronNet's founder and co-ceo is General Alexander who headed up U.S. Cyber Command in the Obama Administration.  He felt frustration protecting critical assets like power companies because he had no visibility as to what was happening on their computer networks.  IronNet monitors networks, removes identifying data that might be competitively sensitive, and shares pertinent data with other companies in the same industry.  If Russia is probing power companies' networks, there may be peculiar behavior on a power companies assets.  If this peculiar activity is shared and it's evident that it's on multiple companies' networks then U.S. Cyber Command can stop it across the industry or even retaliate.  A single detection can be leveraged to resolve the attack for multiple companies.  This "collective defense" is being advocated by the Biden administration, not just for U.S. companies but for a collection of nations.  IronNet sports a $1 billion valuation with a recurring revenue run rate of just $75 million expected at year end.  That's not cheap, but collective defense becomes more valuable as more companies/nations join up.  IronNet could turn out to be a highly profitable software and services company that benefits from network effects.  The Biden Administration just held a two-day global ransomware meeting of nations at the white house where they urged cooperation among countries and businesses.  I don't know how they cooperate without IronNet's solution.

Summary:  A spinoff highlighting assets currently unappreciated by the market followed by a value-adding acquisition transforming a private company into a NYSE-listed one is likely going to cause LGL Group's value to re-rate significantly higher.  Thinly-traded warrants offer leverage, but purchasing LGL common will likely work out well too.

Catalyst

Spin off of MTRONPTI

Value-added acquisition of a private company

Upcoming 10-Q showing IRNT shares on the balance sheet probably with a big income gain