CSI Wireless CSY
July 12, 2006 - 6:45pm EST by
issambres839
2006 2007
Price: 1.50 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 69 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Left for dead from investor exhaustion, CSY trades at six times my earnings estimate after C$0.35 per share of net cash. With a renewed focus on its GPS business that has 20% market share in its growing niche of precision agriculture, and a slew of new products just launched, CSY is in the sweet spot. Yet with cash and securities worth at least C$0.50 a share and C$0.80 a share in valuable Canadian NOLs (net operating losses) CSY is being valued as a distressed business when it is not. CSY should earn at least C$0.20 in fiscal 2007. With comparables trading at 3 times revenue and 20 times earnings, CSY should trade to at least C$3.50 per share in twelve months, and that is a conservative target multiple of 15 times next year’s earnings plus its C$0.50 a share in cash and investments.

Throwing money out the window: the Telematics and Fixed Wireless Story

CSY was a fine little GPS only business before 1999, but it bought a fixed wireless business at the height of the dot com bubble. The fixed wireless and Telematics businesses took them on a roller coaster ride from the highs of almost C$10 to lows at the end of last year of near C$1 a share.

With an empire builder of a CEO, CSY was the ultimate over-promise and under-deliver company. The company hit rock bottom last fall when it disappointed investors in almost every fashion. The company used the cash flows from the GPS business to throw money out the window of fixed wireless. The company had too many employees and expenses that were all to support the grand fixed wireless business, which isn’t even worth discussing, because it is no longer a part of CSY.

The fixed wireless business is gone (sold in May), Telematics is gone and the empire building CEO is gone. What is CSY left with? CSY is left with a great GPS niche business in the growth market of precision agriculture.

GPS and Precision Agriculture

Precision Agriculture uses GPS to plant, fertilize and harvest fields with pin point accuracy.  Instead of using traditional foam markers or guessing, farmers utilizing precision agricultural devices can save time and money with exact usages of fertilizer and fuel. Farmers can also work longer hours in any one day due to relying on GPS and not eyesight. This allows farmers to have a quicker harvest. The newest devices actually steer the tractor or vehicle for you according to the GPS layout of your field.

Precision Agriculture did not exist ten years ago. Now an estimated 20% of U.S. farms use some form of GPS device in their farming. With today’s high fuel prices and high fertilizer prices, it is not hard to see why Precision Agriculture has taken off. Payback can be as little as one year with some crops. Prices on products go from about a few thousand up to $40K and $50K for the high end systems. The average price for precision agriculture systems is $8,585 according to Frost & Sullivan.

Trimble Navigation (NASDAQ: TRMB) and several other competitors estimate that the market is growing 10-15% long term as there is a growing acceptance of guidance and as younger more technologically savvy farmers take over from technologically resistant older farmers. I estimate that some companies can grow higher or lower based upon market share and individual company product cycles.

The largest GPS company is actually John Deere (NYSE: DE) subsidiary, ComNAV. They sell only on John Deere tractors and to John Deere customers and do not participate in the aftermarket. They do about $400 million in revenue.

Trimble Navigation has precision agriculture sales of about $125 million in the aftermarket. Raven Industries is next with $42 million in 2005, and CSY did C$33 million in GPS revenue in 2005. The last big company with any material size of sales is Novatel (NASDAQ: NGPS) has about $10 million in precision agriculture business.

Hemisphere and Outback serve the aftermarket

Historically, an OEM supplier, CSY became vertically integrated with its Outback acquisition in 2005, in which it acquired sales, distribution and marketing assets, along with other GPS products. (Hemisphere is the name of the GPS division that now comprises the whole company)

CSY sells after-market products (think of a getting a car radio at Best Buy as opposed to the dealer’s offering of a car radio) that include GPS guidance systems, DGPS receivers, autonomous GPS receivers, OEM modules and GPS/DGPS antennas. The four brands of the company are CSI, Outback, Satloc and Crescent.

CSY’s products include mapping, yield monitoring, soil sampling and steering products. This enables operators to achieve precise navigation and mapping of their fields to achieve maximum efficiency. Names of the products include: CSI/Satloc AirStar 99.5, LiteStar II, Satloc M3, and the new GPSteer hands-free auto-steering system, plus the Outback S, S2, 360, Hitch, and eDrive auto-steering system.

CSY also offers marine guidance products which enable recreational and commercial fisherman to precisely navigate and map their waters for similar efficiencies. These products can also be used for hydrographic surveying, harbor management, etc.  For the global marine and “machine control” markets, CSI has the Vector, Vector Sensor, and Crescent Vector OEM. They are GPS heading sensors that enable users to maintain accurate headings at substantially less cost than traditional gyro compasses or competing GPS systems.  Also offered is the MBX-3s beacon receiver for various marine applications.

Finally, CSY offers precision GPS products including highly accurate Differential GPS (DGPS) applications, Geographic Information Systems (GIS) & mapping, and surveying systems.  Hemisphere GPS offers a variety of DGPS receivers and OEM modules.  The Bluetooth-enabled PowerMAX is Hemisphere’s newest receiver.

*GIS is a collection of computer hardware, software, and geographic data for capturing, managing, analyzing, and displaying all forms of geographically referenced information.
*DGPS (Differential GPS) is a regular Global Positioning System (GPS) with an additional correction (differential) signal added.  This correction improves the accuracy of the GPS and can be broadcast over any authorized communication channel.

Crescent and a rash of new products

CSY has developed a new chip called Crescent. The company thinks that their new Crescent ASIC is smaller, faster and cheaper than competitors. At the same time CSI should see a nice margin benefit, as they used to source a chip from Zarlink Semiconductor (Toronto: ZL).

Demand was so high for the new products such as their new Outback products and their new Crescent chip based products that the company had problems keeping up with demand and shipping products (more on this later).

This new rash of products should be a real driver in 2007, as the company’s new products completely missed the 2006 buying season.

Numbers have been messy and will be in 2006

The numbers for the company have been a mess. Between closing a division, selling another company, there have been discontinued charges and losses.

To make matters worse the company was late with bringing to market its new products and then had problems shipping them out. In the first fiscal quarter of this year, things were so bad that the company had to ship its products out Fedex to get them out the door. Think for a moment how expensive that was. Then there was overtime wages for the workers.

Further complicating matters, last year the company bought a competitor who also distributed its products. When CSY acquired its distributor it had to account for its own products at the distributor’s COGS, depressing margins tremendously. For example, in q1 gross margins was an abysmal 40%, but management feels that the real margins would have been 47% without the distributor charges.
CSY management believe that “normalized” gross margins are 53%, and this is not hard to get to once you back out enormous Fedex bills, overtime, and production problems. Add in new products and a higher sales level and this should be easy to achieve by year end.

The balance sheet is strong and there is substantial value hidden

CSY has C$11.4 million in cash as of March 31st. They are going to get another C$3.9 million from the sale of its fixed wireless business. Add in seasonal cash flows and the company should have about C$0.35 a share in net cash. More importantly to an acquirer the company has net positive working capital of C$0.50-C$0.60 a share. Then the company also has 4 million shares of Telular (NASDAQ: WRLS) (1.9 free trading, rest contingency). That is another $8 million, $0.17 a share. That gets us to C$0.52 a share in cash and investments.

The company also has $40 million in Canadian NOLs, or C$0.80 a share. It is important to note that Canadian NOLs are very valuable and are much easier to use than US NOLs. A Canadian company acquiring these NOLs can easily use them as long as they have a Canadian business. For this reason the present value of these NOLs is C$0.30 a share.

This means that there is substantial value with CSY before you even get to the operating business. At a minimum, there is about C$0.52 a share in cash and investments. Adding in the working capital and NOLs and to an acquirer, I believe there is at least C$1 a share in non-operating assets. That would indicate at C$1.50, that CSY trades for an EV of C$0.50 a share, or an EV of C$23 million. This for a business with 50% plus gross margins, 20% normalized operating margins (more on this later), in a growing, hot industry, with sales this year of close to C$50 million.

Simply, this company is extremely undervalued.

The first quarter shows the potential for CSY, second quarter should be better

Sales in the first quarter were up 59% for the GPS business. But with all of the production, charges and other issues, the sales gain was overwhelmed with messiness.

As mentioned earlier the company had problems keeping up with demand in the first quarter, which means that the second quarter should see some spill-over effect. Beyond the sales spillover, the charges of inventory from last year’s acquisition are over; meaning gross margins should be close to 50% as opposed to q1’s 40%. Also the balance sheet will look stronger with more cash and shares from WRLS.

Looking beyond the second quarter, the third and fourth quarter are seasonally the weakest. Usually the second half revenue is about half of the first half revenue figure. However, last third and fourth quarter, CSY laid an egg and had two abysmal quarters. So comparisons will be extremely easy and very flattering.

From here on out, every quarter gets cleaner in terms of charges, margins and comparisons. So, there should be a lot of good news on the horizon.

Normalized margins are the key to this investment

The key to this investment is normalized margins. That is why there is so much upside to the company’s stock price. Consider that Trimble Navigation has 27-28% operating margins. Novatel has 32% operating margins (but note that Novatel is a component supplier on the higher end of the market). Raven Industries (NASDAQ: RAVN) also has 26-28% operating margins in their precision ag business.

While CSY competes on the lower end of the market, it has a historical average GPS operating margin of 20-25% based on the last four fiscal years. There is simply no reason why they can’t get back to this range under proper and focused management.

The RHS acquisition last year should have boosted operating margin, and the new Crescent receiver should boost margins, as they used to source it from another company. Even with supply problems, FedEx packages, and overtime, CSY still had a 47% gross margin outside of the inventory charges. I expect the following three things to boost gross margin to 53% by next year:

1) No more supply problems
2) Scale with suppliers, order more volume discounts
3) New product cycle, including Baseline, no full quarter of contribution of new products

So, what is left is operating expenses. CSY plans to take C$1 million out of its operating expenses mainly through staff reductions. I don’t think this is aggressive at all. I would also note that there is at least C$2 million of public company expenses that could probably be eliminated by an acquiring company.

Should earn at least C$0.20 a share in 2007, CSY trades at 6 times that estimate

CSY should do C$48 to C$50 million in revenue in 2006. With 10%-15% revenue growth in 2007, they would do C$55 million in revenue. Take a 53% gross margin with C$1 million in expense reduction with no taxes and this company will easily earn C$0.20 a share.

Note that the company has already guided to “record” earnings in 2007. In 2004, CSY earned $4 million, meaning that the company earns at least C$0.10 a share.

My estimate of C$0.20 a share in earnings is a 17% operating margin on C$55 million in sales. Remember that Novatel, Trimble and Raven do 26-32% operating margins. I believe that I am being very conservative in my assumptions. Further, if CSY can’t get to decent margins, they should and will sell to a better manager and operator who can.

Competitor’s valuations indicate a C$3 to C$4 stock price

The average multiple for GPS companies is very high, which makes the CSY valuation so absurd. Trimble trades at 3 times EV/revenue and 21 times forward earnings. Raven Industries trades at 2.7 times EV/revenue and 18.5 times forward earnings. Novatel trades for 4.4 times revenue and 16 times forward earnings.

CSY trades at 1 times EV/Sales including cash and shares in WRLS but not including its NOLs. And it trades at five times next year’s earnings. At a slightly discounted multiple of 15 times C$0.20 in earnings with its cash and investments, CSY would trade at C$3.50. That is only 133% higher from its current price.

How could CSI be this cheap and offer so much upside?

The stock had been holding up well this year, climbing to as high as C$2.20 on hopes for a focused GPS company that was profitable. Earnings came out and were received well, but May was a terrible time not just for all stocks, but small cap stocks and especially Canadian stocks. Adding in fears of charges against earnings through the rest of the year and 2006 turning into a 2007 story, investors just gave up. In particular, two momentum funds literally dumped their shares at the end of June. Note the big block trade on June 28th.

To me there is no reason why this stock shouldn’t be at least C$2 right now. And as the company proves itself I believe the stock price will recover even further.

Getting prettied up to be sold?

I believe the company could sell itself right now, but why would it with all of the mess in the numbers. Between normalizing production, a new product lineup, normalizing margins, rightsizing the business and eliminating extra public company costs, there are a lot of items that would block a great sale price for the company.

Management owns 14% of the shares outstanding. I believe right now they are prettying the company up and by next year this will be sold. And depending on how good things are a highly valued acquirer could easily pay C$4 a share.

Summary

Last thought, if the company were to do C$70 million in revenue in 2008 and about C$0.40 a share in earnings what do you think the share price would be? That is how much upside and how undervalued the company is. At C$1.50, this stock sells for a quarter of the valuation of its comparables in a sexy, high margin, technology growth sector. This stock is simply one of the best risk/rewards I have come across in years.

Catalyst

1)q2 earnings report
2)higher than expected guidance
3)progressively cleaner gross and operating margin numbers
4)great quarterly comparisons for every quarter this year
5)Sale of the company
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