Description

Short Planar:

Planar is the classic example of a company that no longer has a reason to exist. My price target is down near zero, and I believe the company could start losing money by the second half of 2005. Regardless, earnings will be light going forward and the company is trading at more than 20X trailing numbers.

The company resells (and in some cases still manufactures) flat panel displays for commercial business desktops, medical equipment such as CT-Scans and MRI’s as well as industrial equipment – typically ruggedized machinery for factory floors and mobile use, etc. The flat panel industry has been flooded with competition. $25 billion has been invested in new capacity in the last few years – most of it in Asia. The company now out-sources the bulk of its production, and competition in all sectors is rampant. The result is that the company sells products that are increasingly commoditized every day. In all sectors of their business, the company has no competitive edge or advantage. This is increasingly reflected in their sales and margins. Driving the decline in the stock will be rapidly decreasing margins, a potentially lower top line and higher inventory. Once the company blows its next quarter or two, the price of the stock should come undone.

By Segment, the company’s products are as follows (as per the web site):

Commercial Business Unit: Planar's CBU develops display products for business, government, education, home offices, homes and student rooms. Our products include a wide range of award-winning desktop monitors, touch screens, LCD TVs and plasma displays.

Industrial Business Unit: Planar's IBU develops both standard and custom displays for a wide range of applications that include kiosks, medical, banking, ticketing, point of sale, information display, industrial control systems, transportation and handheld devices. Our customers rely on our unsurpassed expertise in the development of cost effective displays to meet extraordinary performance requirements such as extreme temperatures, durability, vandal proofing and sunlight readability. Planar's display-based systems for retail environments fall under this business unit, which includes solutions for point of sale, point of purchase, kiosk integration and dynamic signage applications.

Medical Business Unit: Planar's MBU develops displays and products specifically designed for medical imaging, patient monitoring and patient care. Our products include radiological and medical-grade flat-panel displays, point-of-care workstations, monitoring and calibration software, analog display controllers and software development toolkits.


Commoditization of Products – Forced Change in Strategy

The commoditization of flat panels has picked up steam dramatically in the last few years. In fact, flat panel production capacity has increased to the point of there being a glut. Prices at wholesale and retail have dropped like a stone and continue to do so.

Regarding its medical division, the company states in its 10K that “the Company’s previous strategy of maintaining significant price differentiation for what was becoming decreasing product differentiation would not be successful over the long term. The Company believes that moving to a price leadership strategy, while preserving the brand equity of the Company’s products in the digital imaging marketplace should allow us to discourage low-cost competitors and derive the most value from our market position.” This language is consistent with the company’s habit of spinning bad news. It is clear that when a company drops its prices in its most profitable division in half, they usually do not brag about it as if they are doing their customers a favor – which is exactly what PLNR did last February in a press release.

In the commercial sector, the company does not invest a dime in R&D. They simply slap their label on monitors and hope that the dynamics of the industry – where they must have lead times with their vendors that is significantly longer than their customers’ lead times – do not continue to crunch their cash flow. In fact, in the past year, inventory has ballooned due to this dynamic. I expect the margins, now at a few basis points, to turn negative in this division. Should this division prove continuously unprofitable, the company will face the reality that half its revenues are unprofitable!


R&D Declining

R&D continues to decline both on an absolute basis and as a percent of sales. This is partly due to basic cutbacks in R&D as well as commercial sales growing as a percent of sales, respectively. The cutbacks will continue to have an impact on the company’s ability to differentiate itself in any material fashion. I think this is somewhat intelligent in that it is almost impossible to differentiate their products. One exception is the company’s push into the retail sector. To my knowledge, virtually every retailer already has flat panel displays. Any push into kiosks will prove disastrous – as shown by the failed history of past kiosk makers. Further, NCR and others are well established at the point of sale. The additional $1 to 2mm in R&D for this project for 2005 alone will prove money wasted.


Reseller Channels

In all sectors of the company’s business, the reseller channels have become increasingly competitive. In medical, they are competing more than ever. In commercial, Dell, with 19% of their business, is focused on its own brand. Go to their web site or look at a catalog and you will see. CDW is not much more friendly and it accounts for 12% of sales. At CDW, you can buy a 19” Planar flat panel for $409. That same monitor was near $1000 a year ago. Planar must price cheaply – else people can choose on CDW’s web site from LG, Samsung, Acer, NEC, Viewsonic, Philips, Princeton, Eizo, and others.


Competition

Competition for Planar has gone from occasional to rampant in every sector.

In commercial desktops, they compete with larger, well-branded companies such as NEC, Sony, Dell-branded screens, HP-branded screens, Samsung, LG, Acer, Philips, Eizo plus dozens of no-name brands including Apex. Dell is PLNR’s biggest reseller with 19% of their business – yet it is has become increasingly difficult to find any brand but Dell on its web site as well as in its paper catalogs. This should materially hit their revenue growth and put pressure on current revenues.

In the medical sector, competition had traditionally come from Barco from Belgium followed by smaller players that were more specialized. Competition from Totoku (of Japan), NEC, NDS and Eizo has now proliferated dramatically. Totoku has reportedly signed a major contract with GE’s medical equipment division as well as one with Eastman Kodak’s medical equipment division. NEC, Eizo and Totoku among others have made major inroads with some of PLNR’s resellers, including Richardson and McKesson.

In the industrial sector, the company faces competition from internal engineering departments within their customers as well as from smaller companies including Global Display Solutions, Three-Five Systems, White Electronic Designs and other small, highly specialized producers. Though there has been a recent increase in the business, competition remains strong and the outlook is difficult.

As per the company’s 10K: “The market for display products is highly competitive, and we expect this to continue and even intensify. We believe that over time this competition will have the effect of reducing average selling prices of our products. Certain of our competitors have substantially greater name recognition and financial, technical, marketing and other resources than we do. There is no assurance that our competitors will not succeed in developing or marketing products that would render our products obsolete or noncompetitive. To the extent we are unable to compete effectively against our competitors, whether due to such practices or otherwise, our business, financial condition and results of operations would be materially adversely affected.” (emphasis added)


Poor Allocation of Capital

Management has made some bonehead decisions lately. First, they are pushing hard into China, the most competitive and least profitable market in the world. Second, they are pushing into Europe into areas where Barco controls the market. Third, they are investing in retail systems – where they have neither experience nor a competitive advantage. Fourth, the company is investing in software systems to differentiate its product offerings, but has no experience doing so. As per the company’s 10K: “Traditional display components are subject to increasing competition to the point of commoditization. In addition, advances in core LCD technology makes standard displays effective in an increasing breadth of applications. We must add additional value to our products in software and services for which customers are willing to pay. These areas have not been a significant part of our business in the past and we may not execute well in the future. Failure to do so could adversely affect our revenue levels and our results of operations.” (emphasis added)

After all of this qualitative information, I will discuss the impact it will have on the company’s profitability. Sell-side analysts, even the most critical, have revenues growing over the next few years. I think that revenues will stay flat as competition and related price declines will eclipse much of the unit volume growth.


Margins

Margins in the most recent quarter were abysmal in all sectors. For 2002 to 2003 to 2004 respectively, earnings in the medical sector have decreased from $12.1mm to $8.8mm to $1.8mm on sales that have gone from $79mm in 2002 to $88.6mm in 2003 and back to $79.5mm in 2004. Thus net margins have decreased from 15.4% to 2.2% over the past three years and show no signs of improving. The industrial sector continues to show decent yet inconsistent profitability with margins around 18%; these margins hit a trough in 2002 at 6.6% and peaked in 2003 at 24.3%. The commercial sector has been a growing portion of revenue, but has shown weakening margins that should turn negative in the next quarter or two. Since the company does not make their monitors anymore, the company should shut this business down. Margins have gone from 3.6% in 2002 to .1% in 2004 while sales increased almost 140%!


Revenue and Earnings

As margins remain weak, the company will fail to achieve profitability in every division save its industrial sector. Once I include new R&D expenses related to its retail concept, marketing expenses for Germany, broader Europe and China and a shift to a higher tax bracket of 35%, profitability will fall dramatically. The current multiple to trailing net after tax earnings is 18.1X. At the 35% tax rate, the multiple jumps to 20.2X.

Going forward: Due to strong competition in the medical sector, I assume the company breaks even as it prices aggressively while spends money on entering new markets. This may prove to be conservative. In the industrial sector, we assume that margins fall to 15% - again probably conservative. This level of profitability has not gone un-noticed by competition. I also assume no losses in the commercial sector. This is incredibly conservative! With the 35% tax rate, the company will earn $7.0mm after taxes. This puts the current multiple to forward earnings of 24X.

But, to be in line with the Street, we must subtract at least $1.5mm for expenses associated with growth of the company’s European sales operation as well as the investment in the new retail business. Some analysts have this ($1.5mm) figure as high as $3 to 4mm. Then, there are the cash bonuses to be paid to executives that were not paid this past year. Those will amount to 5 cents per quarter or $.20 per year – or roughly $3mm. These additional $4.5mm in pre-tax expenses bring down earnings about $3mm. Thus, on an after tax basis, earnings should equal roughly $4mm. With 14.9mm shares outstanding, that equates to $.27 per share. This still leaves us ahead of the DA Davidson analyst, the company’s biggest fan. She has the company earning $.17 next year.

For a company with no differentiating factors and declining earnings and margins, the market will probably not give a generous valuation such as 24X. Yet, even if it did, 24 times $.27 is a $6.44 stock price. Should the market assign a 10X multiple to earnings and give the company full credit for its $2 per share cash position, the company is worth roughly $4.70 per share. Of course, I believe the company will start burning cash on an operating basis by the second half of next year, but that remains to be seen. As a note, free cash flow is fairly similar to earnings with some excess depreciation more than offset by higher inventory requirements.


Capital Structure

To the company’s credit, the capital structure is strong. It currently has $2 per share in cash and no debt. However, the company burned about $7mm in cash in the recent quarter. Some of this was due to inventory growth. I don’t anticipate inventory coming down materially without the company accepting a significant decline in prices and thus margins – which it will. This will flow through the income statement in depressed earnings.

Summary

In summary, Planar is a terminal short with little ability to compete profitably and earn a decent return. The next year will be difficult for the company and I believe the company could turn earnings negative by late next year. Should the company continue to tread water, however, it still has earnings power in the low double digits and thus has an expected price per share well under $5.


Risks to Thesis

- A key risk remains a small market capitalization coupled with a decent sized short interest. I view this as volatility risk – not thesis risk.
- Margins could increase if flat-panel supply costs decrease faster than their average selling prices (ASPs). This is unlikely as many competitors are fighting for the business and are not rational in pricing.
- Competition could fall off as profitability is scarce. This could provide longer-term profit potential. We view this as unlikely as so much capital has been committed to the industry already. This risk also assumes rational competition, which I do not think is the case.
- The company could be bought. I find this unlikely as competition is too fierce and the brand has lost much of its value – something that continues every day. I just don’t see the value to a would-be acquirer.

Catalyst

1. Decreasing sales cut into the company’s image as a growth story. Despite decreasing prices and shrinking margins, the company has had a growing top line, which I believe has helped prop up the stock.
2. Margins in each sector continue to deteriorate putting pressure on the company’s ability to have earnings.
3. Wall Street analysts change their stance from positive to negative. Already, the biggest cheerleader has lowered numbers while qualitatively talking up the stock. This outlook will disappear over the next few quarters and help drive down the stock.