Description

O.I. Corporation (OICO) designs, manufactures, and services instruments used to analyze chemical compounds. It has had very steady revenues for the last eight years, averaging in the neighborhood of $6 million dollars of revenues each quarter. Netting out the cash, OICO, is trading at a 4.66 times EBIT. With $2.95 in cash and investments, the company has an E/EV ratio of 7, implying a 14.4% yield on trailing twelve month earnings, using $0.65 in earnings against an enterprise value of $4.52.

Despite a caution from the company that they have not seen or experienced a fundamental improvement in purchasing and capital spending activity in their markets, revenues have increased 9% for the first nine months of the year, as compared to last year, and profit margins have increased 20%. Gross profit margins increased from 45% to 49% due to a combination of increased revenues, improved sales mix, and a decrease in manufacturing and warranty costs.
OICO does business as OI Analytical, essentially does chemical analysis. Quoting from their website, “The Company provides application-specific solutions for the environmental, defense, pharmaceutical, food, beverage, petrochemical, chemical, semiconductor, power generation, and HVAC industries. End users in these industries use the Company's products for research and development, quality control, analytical services, and process monitoring.” It has 160 employees, and its products are a litany of catchy monikers, namely:
• MINICAMS(R) chemical agent monitoring equipment,
• Gas Chromatography (GC) systems and components,
• Total Organic Carbon Analyzers (TOC),
• Microwave digestion systems,
• Beverage analyzers,
• Gel Permeation Chromatography (GPC) equipment,
• Refrigerant air monitors,
• The Eclipse, a third-generation purge-and-trap sample concentrator, and
• The LAN9000 beverage analyzer (used in quality control to measure sugar and carbonation content in beverages prior to packaging).

Revenues were essentially flat last quarter versus the prior year (up 1%), with a 2% increase in product sales offset bya 10% decrease in services. Product revenues were $6.0M and services revenues were $0.7M. However, net revenues for the first three quarters increased 9% versus the same period last year. Revenues have been increasing in Europe and Asia, while decreasing in the U.S. As an indication, in 2002, non-U.S. revenues were 25%, compared to 18% and 20.5% in the previous two years.

The environmental testing market continues to be OICO’s largest market, and it has been flat to declining for several years. Going forward, the company is trying to adapt to its no growth market by stimulating demand through increased R&D efforts. Their major goals in this effort are to seek new markets, in particular in homeland defense, increase their position in the beverage market, and broaden their product offering in the process analytical instruments market. Although this will obviously impact some of those attractive valuation ratios, I believe that the company has been around long enough to be given the benefit of the doubt that they can be effective in their R&D efforts. As with all their operations, OICO has sufficient cash on hand and funds from operations to adequately fund these efforts.

However, one thing to keep in mind is that the company already does make a significant commitment to R&D. R&D expenses YTD are almost $2 million or 10% of sales, an increase of 18.6% versus the same period last year. All-in-all, given this week’s eye popping improvement in the ISM Manufacturing index—the highest since December, 1983, I’d say that the macro environment suggests that it isn’t unreasonable to assume that OICO should be able to maintain revenue levels comparable to the boringly (and reassuringly) consistent long term record. (22 out of the last 23 quarters have reported revenues within the range of $5.5M to $6.7M.)

Management and buybacks:

The CEO/President/Chairman, William Botts, owns 9.8% of the shares, and over the last eight years, has seen his salary climb from $135k to $187k. Over the same eight years, he has collected a total of $90k in bonuses (total!). Althought I hesitate to overstate the value of non-egregious CEO compensation, that compensation does seem indicative of a company that is managed for the shareholders’ interests. On the other hand, I would speculate that this combination of ownership and compensation suggests that this may be better suited to be a private company. Mr. Botts is 60 years old and has been running the company since 1985.

Although OICO purchased just 7,700 of their own shares last quarter (albeit 20,700 shares in the previous quarter), since 1995, the company has repurchased an aggregate 1.7 million shares at an average purchase price just over four dollars per share. OICO did file an S-8 in June, in which they reported registering 350,000 shares of common stock to be issued pursuant to the Company’s 2003 Incentive Compensation Plan, although the filing only represents permissions, and does not offer any details, quantities, or guidance as to how the company plans to implement such compensation. This plan was adopted in February, 2002, and terminates in 2012. According to the last 10-K, directors and officers held just 59,000 currently exercisable options, so again, nothing egregious. No SARS or options were granted to Mr. Botts during 2000, 2001, or 2002. However, as of 12/31/02, there were a total of 324,000 options outstanding at a weighted average price per share of $4.35. Only one third of these were exercisable.

Other considerations:

I still have a difficult time understanding why some companies bother to remain a publicly traded stock, and OICO falls into this category. As a general rule of thumb, I’ve gone with an assumption that SGA can be lowered by $500,000 per year, by eliminating the increased auditing and reporting costs of being a public company, and with 2.745 million shares outstanding, this hypothetical number would increase earnings by 0.18 per year.

(A good recent source of the breakdown of the additional costs to remain a publicly registered stock company is given in the 13E3 filed by Calloway’s Nursery last week, and from this source, among other various readings, do I pull that $500,000 out of my hat. In fact, on a going forward basis, due to the Sarbanes-Oxley Auditor Full Employment Act, I’d ratchet the number higher by perhaps another $200,000. Although this hurts earnings, it does perhaps increase the catalyst to take OICO private. And, of course, each company being different, it is difficult for me to quantify beyond the blanket generalization of it is cheaper to be a private company than to be an SEC regulated stock.)

Of course, OICO is compelling enough at its current price to justify its purchase, but if one could reduce SGA by 0.18, the above valuations would go to an 18.4% cap rate or a netted out cash value of 3.84 times EBIT. If one penalizes SGA by an additional $200,000 per year, the valuations would go to a 12.8% cap rate or an EV adjusted EBIT multiple of 5.1.

This all being said, OICO seems to be a more straightforward company than the aforementioned example, and listed only $160,000 in audit and related fees for 2002 in their DEF 14A filing. However, as I said before beginning this tangent, the valuation is compelling enough, and we are all familiar with the general argument and catalysts for taking a company private. I’d like to see it remain a public company, as the its stock valuation is considerably more volatile than its relatively steady revenue and income history, and this portends well for creating compelling buying opportunities in the future.

This is not a complex company. It has a compelling valuation, a reassuring long term record of stability in revenues, management, compensation, and buyback practices. It has increased margins on increased revenues while increasing R&D. It has grown both organically and through acquisitions, and both its valuation and its funding requirements suggest that it has little need to be a publicly traded company, but despite the higher costs of operating as such, it still produces consistent and positive earnings and cash flow.

Catalyst:

Attractive valuation, at a cash adjusted EBIT multiple under 5, is the primary catalyst. Secondly, it appears this business could be even more profitable as a private company, given the relatively large and increasing costs of remaining a publicly traded stock in the post Sarbanes-Oxley environment.

Catalyst

Attractive valuation, at a cash adjusted EBIT multiple under 5, is the primary catalyst. Secondly, it appears this business could be even more profitable as a private company, given the relatively large and increasing costs of remaining a publicly traded stock in the post Sarbanes-Oxley environment.