For a period from late 2008 through mid 2009 the GSI Group (PINK:LASR) was prima facie the cheapest stock on my net net screen, but I couldn’t pull the trigger because it was delinquent a few quarterly filings. The company entered Chapter 11 due to the technical default of not filing financial statements and is now an extremely interesting prospect post reorganization. The superb Above Average Odds Investing blog has a guest post from Ben Rosenzweig, an analyst at Privet Fund Management, titled The GSI Group (LASR.PK) – Another Low-Risk, High-Return Post Reorg Equity w/ Substantial Near-Term Catalyst(s), which really says it all. Here’s the summary:
Thesis Summary: Privet Fund LP is long GSIGQ common stock. Our post-emergence price target is $5.00 per common share, an internal rate of return of 123% based on closing price of $2.70 and right to purchase .99 shares for every 1 share currently owned at a price of $1.80 per share. The market has failed to fully price in the impact of the Plan of Reorganization that was confirmed on Thursday, May 27, 2010.
We believe GSI is an attractive investment opportunity for the following reasons:
- Due to the efforts of the equity committee throughout the bankruptcy process, the pre-emergence equity holders will be able to maintain an 87% ownership in the post-emergence company, up from an initial distribution of 18.6% in the first Plan of Reorganization
- The end markets for the Company’s precision technology and semiconductor products are coming out of the trough of a cycle and, as a result, GSI’s bookings have been increasing at an exponential rate
- The purging of the previous management regime opens the door for an experienced operator to run the Company much more efficiently and make strategic decisions with a view toward enhancing the value of the enterprise
- The significant reduction in debt gives management the needed flexibility to focus solely on improving operations. This should result in significant fixed cost leverage going forward as evidenced by the Q1 2010 EBITDA margin of 14%, a figure that previous management suggested was not achievable until the end of 2011
- The current market valuation, which includes the right to buy .99 shares at $1.80 per share, implies a 2010 sales figure and discounted cash flow valuation that is simply not possible even if the Company’s financial performance does not follow through on the radical improvements that have been shown during the past two quarters
I’m not sure that discounting the cash flows back by the WACC is appropriate. After all, how many other investments can you think of where you get paid the long Treasury rate (~ 4.25%) plus 775 basis points just to wait?
I can’t think of any.
This is just my $0.02 worth, but I’d suggest using the long Treasury rate plus 2% like Buffett does, and then it’s either a go or a no-go. It seems pretty obvious, however, that if you discount the cash flows back by 6.25% instead you’re going to like them a lot more than you do currently.
Just some food for thought.
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George, appreciate the feedback. I mistakenly submitted an older version that did not correctly discount the cash flows. However, it would be a mistake to assume that the implied return will fall. As this was originally published 5 months ago, there was significantly less visibility into the business. Therefore, in order to be conservative I had projected $48.4mm in 2010 EBITDA and $59.5mm in 2011 EBITDA. It now appears that they are at least 1 year ahead of schedule, with 2010 EBITDA likely to come in over $60mm. Obviously we won’t know for certain until 2H numbers are released, but this is looking very likely.
Also, I encourage you to read the earnings releases and conference calls from Tier 1 competitors NEWP and ESIO that came out this week. They are very bullish on the company’s end markets in 2011 and describe the operating leverage inherent in their businesses, which could see continued accelerated EBITDA growth in 2011.
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Ben,
Thanks for your through writeup.
“It now appears that they are at least 1 year ahead of schedule, with 2010 EBITDA likely to come in over $60mm. ”
Have you revised your EBITDA estimates based on information released from management, or is this based on the momentum of GIS’s competitors? I’m looking for the source imformation to backup your improved estimate.
Best,
WK
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Wayne,
It was more like that in May I had very little current disclosures to base my estimates on. They were mostly triangulated from the disclosure statement and the bookings analysis that I did to bring the information as current as possible. Since that time, the Company has disclosed 1H EBITDA of roughly $27mm with Q3 bookings and backlog growing sequentially. Couple that with the color given by their competitors and you see how my May estimate was very low. I can’t give more concrete figures than that but channel checks and conversations with the Company have only made me more bullish.
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From 9/3/2010 press release:
“During the third quarter of 2010, as a result of the Company’s emergence from bankruptcy, including the completion of its rights offering, the Company had approximately 100.0 million common shares issued and outstanding on September 3, 2010.”
I wasn’t clear to me while reading the thesis, but the Rights Offering has come and gone. I hope new buyers understand this before getting involved.
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Thanks for posting. I really enjoy reading your site.
I found the thesis very compelling and I liked the way the analyst laid out the situation with management and the debt holders. I went to the presentation from the full report and I was pretty excited until I encountered the DCF analysis.
The DCF analysis appears to be overvaluing the company. The Unlevered Free Cash Flows do not appear to be discounted while the terminal value is discounted. Discounting the Unlevered Free Cash Flows by the WACC of 12%, The Total Discounted Cash Flows should be $453,438 ($28,920+$36,377+28,389+$29,817+$329,936).
With 109,013 shares outstanding, the DCF Value per Share is $3.76 vs $4.53 in the presentation. The Implied Return falls to 39% vs 68%. While still an interesting discount to intrinsic value, the risk-return profile is less interesting.
It appears that the discount formula is missing from the DCF analysis. Otherwise, I like the analyst’s thesis.
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