If you must speculate: Force Protection Inc.
- Published in Finding Alpha
- Read 6715 times
Investment and Speculation are two very distinct activities. Speculators believe they can see into the future, and more particularly, believe they have some sense of future security prices. Investors accept that they do not have any special foresight, and instead focus on an entirely different set of criteria. It is best not to speculate, since the foundation upon which speculative decisions are likely to be based are invariably little more than “best guesses”. If the urge to speculate cannot be resisted, consider giving 95% of your funds to a value-oriented investment manager who is well vetted and who you trust. Keep the other 5% and go to Vegas (at least you’ll have fond memories to make up for the loses).
Alternatively you could buy Force Protections stock (FRPT) – it’s not quite investment quality, but it is very nearly. A reasonable downside assesment might be about 10%, but the real value of the company is probably 45% greater than the share price today. We’ll explain more below.
Why we categorize Force Protection as “speculative”:
- The issue is relatively young and small.
- Has high customer concentration (although this is gradually changing with international initiatives)
- Has narrow product offerings (you can count their sku’s on one hand)
- Future earnings power does not hinge on consistent, growing demand, but rather a few large contracts which they may or may not win – making the future earnings picture very hard to discern – and speculative.
- Operates in an industry where aspects of the product are undisclosed
- Means by which contracts are awarded not easily understood.
- Defense spending in under pressure as part of budget cuts.
- Sales have been declining as troops are drawn down in Iraq and talk of draw-down in Afghanistan continues (very different circumstances than say five years ago).
- The company does not pay a dividend
Yet as speculations go Force Protection is about as safe as they get.
Some positive qualitative factors:
- Extremely well capitalized and trading below equity
- Stabilized operating margins over both TTM and the last five years (although earnings are low)
- New CEO seems to be stable personality type driven to win new contracts while maintaining emphasis on sound financial management.
- Despite reversal in operational tempo in Iraq, company has not yet lost money, revealing that a majority of the company’s existing fleet (a major source of recurring revenue) is located elsewhere.
- Improving gross margins
- Won an important new contract in 2010 that is likely a stepping stone to other larger contracts (discussed further below)
- Responded quickly to reduce SG&A in US while opening indigenous offices in markets with new contract potential, including Canada and Australia.
- Resolved pending litigation at relatively minor cost.
- Board approved $20 mln. share buyback (also discussed further below)
- Officers are exercising options but not reselling shares.
A look at future contracts:
Winning the UK MoD contract for the new light protected vehicle couldn’t have been easy. The UK military is well respected and apparently some thirty manufacturers competed for this contract. The initial contract was valued at 280 mln. (or just slightly less than FRPT’s entire market cap at 66 mln. shares). This is an urgent operational requirement for the UK MoD, with vehicle deliveries beginning this fall. Once the production line is up and running, we believe the UK MoD will act on the suggestion that they will procure an additional 200 units, that is another 280 mln. in revenue.
FRPT is also bidding on two other large and important contracts. The first is Canada’s TAPV program valued at more than one billion dollars, for which force protection has already been down selected.
The second is Australia’s Land 121 Phase 4 program for 1300 vehicles and valued at more than 1.3 billion. Force Protections Ocelot has been down selected for this program as well, and now competes against only two other vehicles for this contract. One of the competitors is a legacy model developed over ten years ago (which is ancient in the MRAP business), the other has only made an appearance as a digital rendering – not a good sign. The Ocelot on the other hand, represents the latest in innovation (the modular design coupled with a "pod" made from compsite materials is fascinating) and has an assembly line which is already hot. The total value of these three contracts is roughly 2.6 bln. We believe that FRPT’s chances of winning are better than 50% in both Canada and Australia, and much higher for a second UK MoD award.
US contracts for spares, sustainment and upgrades for the existing fleet of vehicles already in service make it likely that FRPT will grow its revenue over 2010, even without winning these new contracts. With improved gross margins, and no lawsuits to settle, it seems reasonable that earnings will be higher for 2011 (albeit recognized in the back half of the year).
Analysis of the Product – A Sound approachIn the absence of detailed proprietary information on the design and build of FRPT’s products, we are forced to resort to the next best method; the time honored “twelve year old” approach. Although highly analytical, and requiring a professional pedigree, we think the more common, but less developed of the species, the "male investor" will understand it; "if it looks really cool, and like it could blow things up – it must be good". We were able to confirm the first criteria, but are still checking on the whole “blow things up” part…
If this approach is found to be defective in anyway, the investor could always rely on the first rate endorsement by the United Kingdom Ministry of Defense, which may have applied an even more sophisticated approach.
A look at the numbers:
|
Financial Condition - A |
|
|
Current Assets |
$ 418,762,000.00 |
|
Current Liabilities |
$ 152,742,000.00 |
|
|
|
|
Current Ratio |
2.74 |
|
Financial Condition - B |
. |
|
Total Assets |
$ 482,704,000.00 |
|
Total Liab. |
$ 154,277,000.00 |
|
|
|
|
Net Current Assets (C. Assets – Total Liab.) |
$ 264,485,000.00 |
The company is cheap by any measure. But it gets even cheaper when the above mentioned share repurchase is taken into account. 20 million in share repurchases may not see like a lot, but when the small size of the company is taken into consideration, the impact is significant.
If we assume the company is purchasing its own shares in the open market somewhere between $4.50 and 5.00 per share (let’s call it $4.75 per share), we can estimate that the company will be taking back some 4.2 million shares more or less. This number amounts to about 6% of the shares outstanding, and has a related effect on inter-quarter calculations of EPS and Market Cap.
While this is still just an assumption, we think it is a fair assumption regarding when the company may be buying their own shares, and how much their paying. Given that the company consistently has higher earnings in the back half of the year, one would expect share prices to also be higher during that time – a point surely not lost on the management of the company.
For the sake of analysis and since the share repurchases are inevitable, we have based the following earnings, price and equity exhibits not on the 70.5 mln. shares outstanding at FYE 2010, but rather on a revised estimate of 66 mln.
The numbers: (revised share calculus)
|
Earnings |
|
|
EPS (ttm) |
0.22 |
|
EPS as % of current share price |
4.8% |
|
P/E |
20.6 |
|
|
|
|
MRQ |
$ 11,200,000.00 |
|
MRQ annualized (available to common) |
$ 44,800,000.00 |
|
% of current market cap. |
15.0% |
|
operating income/equity |
13.6% |
|
|
|
|
MRQ EPS |
$ 0.16 |
|
MRQ EPS (annualized) |
$ 0.64 |
|
MRQ EPS (annualized) / current share price |
14.1% |
The EPS over the last twelve months is nothing to write home about. however, if the investor believes that this company has turned a corner, and the best days lie ahead, as seems to be indicated both by the settlement of the lawsuit and the success of the new Ocelot program (not to mention the extremely good prospects for both the Canadian and Australian programs), than the low EPS figure and its related high P/E ratio is acceptable.
After all, if stocks are to be purchased on a discount basis, and the market has a general preoccupation with the earnings coefficient (even though it is the most elastic), than buying at a discount will usually mean, a period of temporarily low earnings, and paradoxically, a high P/E ratio. But is the EPS really low and it's derivative high? We’ll discuss further below.
Price and Value considerations:
|
Price |
|
|
Current Price |
$ 4.54 |
|
Net Working Capital per Share |
$ 4.01 |
|
NWC as % of Share Price |
88.3% |
|
Approx. shares Outstanding (post repurchase) |
66,000,000 |
|
Market Cap. |
$299,640,000.00 |
|
Shareholder Equity |
$328,427,000.00 |
|
Net Tangible Assets |
$313,205,000.00 |
|
Book Value Per Share |
$ 4.98 |
|
Current Price to Book |
0.91 |
At a share price of $4.54 per share, a full 88.3% (or $4.01 per share) of the price is made up just of Net Working Capital, (current assets minus total liabilities). We have estimated the downside risk based on this information. That is to say, if the price fell an additional 11%, the stock would be selling not just below equity (95% of which is tangible), but would indeed be selling below net working capital – we think people would notice.
Growth in owners’ equity over the last five years:
|
Net Assets Securing the Issue (Owners Equity) |
FYE |
YoY increase |
|
2006 |
$ 217,854,000.00 |
|
|
2007 |
$ 231,629,000.00 |
6% |
|
2008 |
$278,327,000.00 |
20% |
|
2009 |
$ 311,091,000.00 |
12% |
|
2010 |
$ 328,427,000.00 |
6% |
|
12 month forecast |
$ 364,412,862.03 |
|
|
Avg. increase: |
11% |
|
|
Forecast book value per share (1 yr.) |
$ 5.52 |
|
|
1 yr. price at today's discount to book |
$ 5.04 |
|
|
1 yr. intrinsic value est. |
$ 8.28 |
Owners equity has grown at a consistent 11 percent per annum over the last 5 years. If FYE 2010 figures are multiplied by this factor, we can safely project a book value of $5.52 per share within one year. The high level of real asset backing combined with the investors’ natural aversion to short-term capital gains tax, makes (in our mind at least) today’s price as good as one year from now- and paramount to a book value of .82.
So you’re filthy rich and prefer to buy whole companies… the “Icing on the Cake” affect.
When considering an investment in common stocks, sometimes it helps to consider the prospects of the company as if acquiring the entire business, rather than a fraction of it. Considerations from this perspective help eliminate distorted feelings, and return the perspective to one of an enterprising business owner.
At 66 mln. shares, Force Protection is selling at about 30% of the 2010 order book (1 billion) and a mere 53% of their 2011 funded backlog (560 million). If the most recent quarterly earnings (Q4 2010), are annualized, than divided by the (revised) market cap., the coefficient is .15. In other words, a buyer of the entire business would recover his investment through net earnings in 6.67 years.
Even if Force Portection fails to win the Canadian and Australian contracts, it seem evident the company can secure at least 1 billion in annual sales from existing customers. The present liquidation pricing puts zero value on the company as a going concern, it’s intellectual property, inevitable future sustainment business, or good will amongst it’s growing customer base – a buyer today would get all of those things for free.
Now for the Icing on the cake - a buyer of the entire business today would be set back 299 mln. for tangible assets of 313 mln. - a 14 mln. discount for assets worth at least one hundred cents on the dollar (or trading .95 cents for dollar bills in return). But as Billy Mays would say: “but wait there’s more...”
Of the 299 mln. you would be spending, almost exactly 50% would be for cash and short term inventory. Since FRPT’s customers are governments (primarily the US government), and always pay – let’s just call it all cash (check the “allowance for doubtful accounts” entry).
Since half of the 299 mln. price tag is a paper trade, the real price for acquiring the company with it’s very good future prospects is just 150 mln. Below are the numbers presented in light of this consideration:
|
Effective Earnings (less cash in acquisition) |
|
|
EPS (ttm) |
$ 0.23 |
|
EPS as % of current share price |
9.7% |
|
P/E |
10.3 |
|
MRQ |
$ 11,200,000.00 |
|
MRQ annualized (available to common) |
$ 44,800,000.00 |
|
% of current market cap |
29.9% |
|
operating income/equity |
13.6% |
|
MRQ EPS |
$ 0.16 |
|
MRQ EPS (annualized) |
$ 0.64 |
|
MRQ EPS (annualized) / current share price |
28% |
The TTM EPS value as a percentage of current share price, is now something to write home about - and the investor need not care as much if the company has “turned a corner” just yet. With an acceptable EPS/share price figure and low P/E ratio, the speculative features of the issue are minimized.
Revised Price and Value considerations:
|
Effective Purchase Price (less cash) |
|
|
Effective Purchase Price Apr-14-2011 |
$ 2.27 |
|
Net Working Capital per Share |
$ 4.01 |
|
NWC as % of Share Price |
176.5% |
|
Shares Outstanding |
66,000,000 |
|
Market Cap (less cash) |
$ 149,820,000.00 |
|
Shareholder Equity |
$ 328,427,000.00 |
|
Net Tangible Assets |
$ 313,205,000.00 |
|
Book Value Per Share |
$ 4.98 |
|
Current Price to Book |
0.46 |
If the non-cash part of the share price is $2.27, the shareholder today would receive 176.5% of this “net-net” asset value post acquisition.
We have roughly estimated the intrinsic value of this company based on this information – it is not a science, but we think a value of some 45% above the current market cap is conservative given FRPT's sound financial management and future promise.
Now for some serious speculation: If the effective purchase price of the company at todays market cap. (with the UK MoD’s huge endorsement) is only $150 mln. net dollars, then couldn’t one of FRPT’s competitors simply purchase them, even at say a 50% premium to market cap. (effectively 300 mln. net dollars) in order to increase their odds of winning these other billion dollar contracts? In this context, a 150 mln. premium over tangible assets, seems like a pittance, even if the contracts are never won.
What if there were a contract so large, that highly specialized and successful MRAP builders like Force Protection, who already have next generation products in production, became the acquisition target du jour? A 150 mln. acquisition premium, might well seem like a $150.00 premium.
Or perhaps one might speculate that a large private equity firm with an expertise in aerospace & defense might see both value and huge upside potential and would purchase the company. But we suppose if that were to happen, the private equity firm would probably first put one of their own on the board… Oh, well scratch that idea…
Either way, if you must speculate, you might want to consider Force Protection, Inc.
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Amvona publishes critical articles and interviews at the intersection of Faith, Finance and Economics.