Value Investors Club / OPT-SCIENCES CORP (OPST)

Description

Opt-Sciences Corporation (OPST)

We have been shareholders of Opt-Sciences Corporation (OPST) for over ten years and fully

expect to remain shareholders for the next ten years! Over the period the shares have more than

tripled from approximately $6 per share to the current $19 per share. The shares were

substantially undervalued when we purchased them ten years ago and remain materially

undervalued today, despite over a 200% return over the period.

OPST is a very conservatively run Company with a focus on building long term value and not

quarterly results. As one of the Company’s Board members recently put it during one of our

recent discussions, “OPST is one of the safest companies in the market!” We strongly agree.

OPST is essentially a pile of cash, (conservatively managed, diligently protected and generated

by the consistent profitability of the business over the decade), attached to a great business with a

solid sustainable moat. The Company has no debt or long term liabilities and a current ratio of

25.0!

OPST, formed in 1956, is in the business of depositing anti-glare and/or transparent conductive

optical coatings on glass used primarily to cover instrument panels in aircraft cockpits. The

Company also provides full glass cutting, grinding and painting operations which augment the

optical coating capabilities. Most of the Company’s products are designed to enable pilots to

read aircraft instruments in direct sunlight or at night or in covert operations using appropriate

night vision filters or to protect the instruments from electromagnetic interference. This is a

niche business primarily dependent on the needs of new and used aircraft for initially installed

parts, spare parts, replacements and upgrades. It requires custom manufacturing of small lots of

products to satisfy specific customer requirements. What gives the Company a solid moat is that

once the product is “designed in” a customer’s aircraft it remains there for the life of the

particular aircraft. Changing the optical coating supplier requires an extensive and expensive

recertification process that customers rarely undertake.

The Company is currently an approved vendor for major aircraft programs. OPST continues to

be a major supplier for the anti-glare face plates covering the flat panel displays on the Boeing

777 and the 737 Next Generation models of commercial aircraft and the long range Gulfstream

and Dassault Falcon business jets. The Company is also an approved vendor for instrument glass

used on several military aircraft platforms including the C5 Galaxy and the C130.

The Company enjoys a 20% to 25% market share in the US. It has four major competitors, who

are either private or divisions of large corporations. Hence, industry data is very limited. Given

the niche character and size of the market, there clearly exists an opportunity for consolidation.

OPST management is cognizant of this and is interested in possibly buying a competitor or

selling the Company. Given OPST’s cash position and future prospects, we would prefer the

purchase of a competitor.

OPST Income Statement

(Dollars in Thousands)

2015 (6 Mos) 2014 2013 2012

Net Sales 3,579 7,074 6,220 6,887

Cost of Sales 2,101 4,611 3,953 4,663

Gross Profit 1,478 2,463 2,266 2,024

Operating Exp. 596 1,219 1,100 1,031

Operating Income 883 1,244 1,167 923

Other Income 202 497 318 493

Pre-Tax Income 1,084 1,741 1,485 1,486

Taxes 423 627 541 541

Net Income 662 1,114 943 944

EPS 0.85 1.44 1.22 1.22

Gross Margin 41.3% 34.8% 36.4% 30.3%

Operating EPS 0.69 0.98 0.92 0.78

Cash/Share* 15.60 14.51 13.40 15.08

Share Price 19.00 19.00 19.00 19.00

Net Share Price 3.40 4.49 5.60 3.92

Net Price/

Operating EPS** 2.45 2.30 3.05 2.51

* Cash balance in fiscal 2013 is lower due to a $.65 dividend and a $0.5 milliom increase in accounts receivable.

** Annualized for 2015.

As can be seen from the historical results, the Company has been consistently profitable, with

improving margins, consistent sales and a stable cash position. (In fiscal 2013 the Company paid

a $.65/share dividend and had a $0.5 million increase in accounts receivable.) The attractive

economics of the coating business are obscured by the large cash balance. We calculated a price

to earnings ratio excluding the cash and excluding the earnings on the cash. On this basis the

shares trade for 2.5 times operating earnings!

With the business unambiguously cheap, the issue becomes the cash balance. First, as of fiscal

year end 2014, the portfolio was conservatively invested with 29% in cash, 42% in fixed income

securities, 29% in preferred stock, and 5% in common stock. And the management has no

delusions that they are great stock pickers and want to aggressively invest their cash. Their

objective is to conserve capital. The second obvious question is, “What is the purpose of the

cash?” We have argued with management that the cash is in excess of the needs of the business

and should be used to pay dividends or buy-back shares. Management did pay a dividend in

fiscal 2013, but we should not expect this to be the primary use of their cash. The Board has

adamantly and confidently argued that they need the cash to protect the business from potential

cyclicality and to take advantage of business opportunities to expand their facilities or possibly

fund the purchase of a competitor. Although we don’t completely agree, after ten years with

management we respect their opinion and are confident that the cash will not be used frivolously.

In fact, the Company is currently expanding its facilities to accommodate larger glass. The

Company is spending $1 million to $1.5 million to purchase new machinery. As they put it, their

objective is to expand their market coverage while retaining their legacy business. They always

want to have product ready when the customer needs it or at some point you will be “designed-

out” of the next aircraft.

Management and Board

On first analysis the management structure may be cause for concern, but after ten years of

observing how they run the Company, we are much more comfortable. The Arthur John Kania

Trust owns 66% of the outstanding shares and thus controls the Company. The Board has only

three members: Arthur J. Kania (83) who established the trust for the benefit of his children;

Arthur J. Kania, Jr, (59) who has no operating role in the Company: and Anderson McCabe (59),

who is the CEO and runs the Company. The concern is that the two Kania’s are father and son

and McCabe is the older Kania’s son-in-law. This raises the obvious red flags, but we have found

no evidence that the Company has been run simply to enrich management and the Board. For

example, the CEO, McCabe, receives a total annual compensation of $194,000. The two Kania’s

receive $15,000 each of annual director fees. There are no options or share awards. The only way

management and the Board prosper is if all shareholders do well. The only concern we have is

that they may be too conservative in protecting the Company’s assets and not that they are

enriching themselves, which is not a terrible problem.

Valuation

We touched on valuation when we analyzed the Company’s performance, noting the OPST

currently sells for less than three times operating earnings. During the latest quarter the book to

bill ratio was 1.54 and the back-log was up 45%. The Company is now on track to earn $1.50 per

share in operating earnings in fiscal 2015, which ends in October. The Company had $15.60 per

share in cash at the end of the second quarter. Let’s discount this cash and conservatively assume

$1.60 per share is needed to run the business. This leaves $14 per share in excess cash. As for the

expected earnings, let’s give them only an extremely conservative multiple of eight times. Thus

the valuation of the Company would be $14 in cash plus eight times the $1.50 in expected

earnings or $26 per share (a 37% premium to the existing share price)! Even this would be an

extremely cheap valuation as it gives no credit for the expected growth or the earnings stability

of the Company.

Summary

1) OPST sells for less than three times after tax operating earnings.

2) The Company has a consistent record of profitability and cash generation.

3) The Company is very conservatively managed for the long term.

4) The Company is in a niche business with a solid moat.

5) OPST has $15.60 per share in cash, no long term liabilities, and a current ratio of 25.

6) The Company has expansion and consolidation opportunities.

7) The business conditions are currently very strong.

8) Management incentives are aligned with outside shareholders,

9) Its cash position is very conservatively managed.

Concerns

1) Management controls the Company, holding two thirds of the shares.

2) The Board has no outside directors.

3) The shares are very illiquid and require patience to purchase.

4) A significant percentage of the valuation is in cash which could theoretically be

squandered by management.

5)Their business is concentrated with several major contractors and manufacturers.

6) Management is not expected to pay a dividend.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1) Honestly, we don't need a catalyst. We would be content to participate in the growth of the business.

2) Sale of the Company to a competitor.

3) Children of founder seek liquidity.

4) Company decides to buy-out outside shareholders with excess cash.

show sort by

			2015	2016
Price:	19.00	EPS	1.90	2.0
Shares Out. (in M):	1	P/E	10.0	9.5
Market Cap (in $M):	15	P/FCF	10.0	9
Net Debt (in $M):	-12	EBIT	2	2
TEV (in $M):	3	TEV/EBIT	1.4	1.3