Description

Polymer Solutions Inc. (PYSU) is a California-based company that manufactures paints that emit low levels of volatile organic compounds (VOC). VOC’s have been linked to increasing smog levels. Most of PYSU’s paints are used to coat furniture. Furniture companies are limited by law in the levels of VOC’s that they can output, so using low VOC paints allows them to increase their productivity. A new Southern California law that is supposed to go into effect some time in 2002 will further restrict VOC output. PYSU’s coatings are well within the restrictions imposed by the new law.

All of this is fine and dandy, and it might lead to more business for PYSU, but what makes PYSU a compelling investment is simply valuation. Since moving into a new state-of-the-art manufacturing facility two years ago, PYSU has been profitable, and has generated substantial FCF. Last year the company made 0.11 per share of FCF. Price to trailing FCF is an unbelievable 3.36. Through the first nine months of this year, including the brunt of the recession, PYSU has made 0.06 per share of FCF. Annualized, this equates to about 0.075 per share, yielding a price to FCF of 4.93, again ridiculously cheap. As we move out of the recession, business should improve.

The news gets even better. Over the past five years PYSU’s revenues have more than tripled from $5.0 million to $15.4 million (note that $3.5 million of this revenue growth came from an acquisition). And there is plenty of room for additional growth. The U.S. far west market for PYSU’s paints is approximately $3.4 billion. PYSU’s low VOC coatings have been stealing market share there from some of the major paint companies (e.g., Sherwin Williams, Akzo Nobel, etc.), and some of PYSU’s accounts are national, so they’re not limiting themselves to the far west market. So, this isn’t a turnaround or value play, it’s a rapid-growth-at-an-amazingly-cheap-price play.

In addition, according to their most recent balance sheet, PYSU has no bank debt, a current ratio of 4.0, and a new $3 million credit line, so they should be in business for some time to come, even if the recession deepens. They do have long term capital and operational lease obligations totaling over $2 million, but the largest obligation in a single year is less than $0.5 million, so this isn’t likely to be a problem.

In addition, because the company lost money prior to the past two years, there are substantial NOL’s which they are now taking advantage of to reduce their taxes. According to their most recent 10K, as of March, 2001, they had $1.3 million of tax benefit remaining; management expects to realize all of it, which would require taxable income of approximately $3.8 million, which is more than the company’s current market capitalization.

Last year’s ROIC was a conservatively calculated 14.6% (i.e., the numerator was adjusted for taxes even though the company still benefits from prior NOL’s). Actual ROIC will be substantially higher until the NOL benefits are used up. Operating profit was 8.1%. Though already decent, both figures should improve as the company continues to grow revenues, and benefits from economies of scale.

The story continues. PYSU’s new manufacturing facility has the capacity to generate $50 million of coatings, more than three times current production, so don’t expect large expansion expenditures any time soon. If you’re worried about an exit strategy, it should comfort you to know that, according to their web site, PYSU’s long term strategy is to eventually be acquired. Management believes the company will need to generate a minimum of $25 million in revenues before the larger paint companies would be interested in acquiring them. They mention that recent acquisitions have ranged from 1.4 to 1.9 times sales which would value PYSU from $1.80 to $2.44 per share, substantially above their current $0.37 per share price. Please note that these figures assume that all options and warrants would be exercisable. Even though most outstanding options and warrants are well out of the money, if the price of the stock were to increase substantially, this would have a meaningful dilutive effect.

Management owns 26% of outstanding shares, a meaningful amount but not enough to control the company. Now that the company is cash flow positive, they recently started a stock repurchase plan; thus far they have repurchased 83,300 shares.

Of course, there are some concerns related to PYSU. Since the company is so small, it would be difficult for those of you who manage large funds to take a meaningful position. Also, the spread is large, currently a bid of $0.25 and an ask of $0.37; I used the ask price in my analysis, since it’s the price an investor would have to pay for the stock. As eluded to in the previous paragraph, there are a lot of options and warrants currently out of the money that could keep the stock price down if buyers should come in, 2,641,019 shares to be exact. Most of these additional shares are warrants issued by the company in connection with their 1999 acquisition of another paint company; all warrants will expire at the end of next year, easing this potential dilution effect. Currently, diluted shares outstanding are 9,326,966. Last year approximately 789,500 options were issued which equates to 8.5% of outstanding shares. This is more than I would like to see, but not extremely excessive. In addition, management’s compensation is $200,000 or less per person, which is reasonable. According to their website, PYSU is aggressively seeking smaller companies for acquisition. This increases investment risk because of the possibility that management might overpay or take on too much debt for an acquisition; however, if done prudently, it should lead to more rapid growth, economies of scale, and recognition by both the market and larger paint companies that could acquire PYSU.


Market Cap: $3.45 million
Revenues: $15.4 million
Cash Flow from Operations: $1.30 million
Capital Expenditures: $0.26 million
Free Cash Flow: $1.04 million
Income from Operations: $1.25 million
Current Assets: $4.77 million
Total Liabilities: $1.60 million
Diluted Shares: 9.3 million

Catalyst

Near term: Passage of tougher laws restricting VOC emissions, valuation, and continued growth and profitability. Longer term: Acquisition by a larger paint company.