Description

BUSINESS
At around 1.1X Net current assets, Mead Instruments (MEAD) represents an attractive investment opportunity for value investors. Mead operates in a business which is very competitive, but in which it has established a position as an innovative player. It is a company that is poised to reap the benefits of past acquisitions, and successful new product releases while at the same time providing safety in the event of operational hiccups by having a strong balance sheet.

Meade Instruments Corp. is a multinational consumer optics company that designs and manufactures telescopes, telescope accessories, binoculars, riflescopes and other consumer optical products. Its business is segmented around 3 major areas - 1) Telescope and Telescope accessories (52% of sales), Binoculors (22.5%) and Riflescopes(19%).

The optics business has become very competitive. It is pretty easy to go out, buy a ticket, fly to China and buy what everyone else has. However, Mead has a strong focus on product innovation and has a history of creating products that stand out from the clutter. Some of its products are heavily patented, protecting it from cheap "me-too" competitors. As an indication of its commitment to product development, the Company spent $2.0 million, $2.0 million and $3.0 million on research and development during fiscal 2005, 2004 and 2003, respectively, and has, over the last five fiscal years, committed $11.3 million in the aggregate to research and development. The company's business is seasonal. Historically, sales in the third quarter have been higher than sales achieved in each of the other three fiscal quarters of the year. Thus, inventory starts coming down after the third quarter (Fiscal year ends Feb 28th, each year).

Mead did $111.8 million, $138.28 million and $110.8 million respectively in the fiscal years ended Feb2005, Feb 2004 and Feb 2003. One of the main Causes of the falloff in 2005 sales was a $19 million decrease in Telescope sales. This was due to a celestial event in 2004 (yes really!!!). The planet, Mars, passed notably close to earth during 2003. As a result, sales of telescopes were particularly high during that time. The company, thus got caught with a lot of inventory in the field which it had to work through during 2005 and Q1 2006. To tackle this issue, they changed the way they work with the dealers. Now, telescopes are drop shipped from the factory itself to give management higher visibility into the channel.


ACQUISITIONS -
Management has been very good at making accretive acquisitions. Since 1999, they have made 3 acquisitions - Bresser (for its significant presence in binoculors and low price telescopes, as well as to help the Company's penetration into European markets) in 1999, Simmons Outdoor (For its Riflescopes and sports optics) in 2002 and Coronado Technology (for its high quality hydrogen alpha filters and solar telescopes) in 2004. Though the company does not break it out in detail, as per management, all three acquisitions are doing well. The company has been able to introduce innovative products as well as increase sales. For example, they paid $20 million for Simmons (which at the time was doing $20 million in runrate sales). Simmons does about $30 million in sales today.

SIMMONS ISSUES -
Sales during the second quarter of fiscal year 2006 were relatively flat compared to the prior year’s second quarter. Sales at the Company’s European subsidiary increased approximately 20% over the prior year quarter. That increase was principally due to sales of Meade and Coronado branded telescopes. This was driven by new product introductions like RCX400 series of high-end telescopes and the DSI astro imager. However, due to supply problems at Simmons' Asian factory, Simmons' sales decreased almost 40%. This was unfortunate because Simmons' riflescopes had received excellent reviews (in an industry charecterized by lacklustre innovation). The company has responded by working with a second source for the product in Asia. What is most interesting is that the retailers have been very supportive. They know that they have a good product and the company expects to get back the shelf space once production comes back on line.

VALUATION -
Market cap is around $50.8 million. The net current assets are $47.1 million or the company is trading at a very attractive valuation as compared to its net current assets. Book value per share is $3 and at a current price of $2.54, P/B is 0.85. The market is thus ascribing no value to its franchise. Management has stated that the book value of inventory is strong and is not expecting any writedowns in the near future.

Another way to look at it is this: the company paid $20 million for its Simmons subsidiary when it was making $20 million in sales (today's runrate is $30 million). Management has said that it won't sell Simmons for $20 million today. Current EV = $50.69 million. Or the the market is valuing its Telescope business at $31 million - a business that can generate $70 million in sales annually.

Normalized EPS for this company is hard to estimate due to the volatility. The company did $0.84 in EPS in FY 2000 - when it was firing on all cylinders. At a 12 multiple, this translates to a $10 stock price. If we consider that the high end of the range, and the fact that the company is trading around net current assets today, the current stock price of $2.54 provides a floor. As the company's products hit their stride, the stock can trade considerably higher based on a very conservative P/E multiple.

OTHER FACTORS
I like to see a management that is in the same boat as the shareholders. All current directors and executive officers of the company own 15.1% of the stock. Steven Murdock, the CEO owns 10%. Management has stated that the stock is undervalued and would have bought back stock. However, the bank loan covenants have prevented them from buying back stock.

Investor Paul Sonkin of the value-oriented Hummingbird Value Fund (which I am not affiliated with) is a 8% shareholder (and has been buying around current prices). The presence of this significant outside shareholder could eventually provide a catalyst to more fully realize value, potentially through a share buyback or an MBO.

Catalyst

New high margin product introductions leading to increased sales.
Issues at Simmons' Asia factory get resolved.