|Shares Out. (in M):||9||P/E||14.4||12.1|
|Market Cap (in $M):||98||P/FCF||0||0|
|Net Debt (in $M):||10||EBIT||11||14|
FEIM operates a few different businesses but they primarily operate as a niche provider of mission critical timing and frequency devices in the satellite industry. The stock has no analyst coverage and is down 30% from its high reached in April. I think it will be trading at least 50% higher by year-end, could be a double if you take a longer-view (over 1 yr. out) and I think it could be acquired within the next year or two.
I see three primary drivers to close the gap between today’s price and an appropriate valuation and these are rapid EBITDA growth, the potential divestiture of a division, and management’s commentary on the last call that they are open to selling the company.
EBITDA should grow >70% this year and more than double over the next couple of years yet this is trading for a MSD multiple of EBITDA at about 6-6.5x.
Management elaborated on their desire to potentially sell a division of the company by year-end after saying the following in their F3Q’15 press release, “we are ready to handle larger new satellite payload contracts. Looking ahead, our focus will remain on potential corporate transaction opportunities and on rationalizing our segment assets and operations in order to enhance shareholder value.” More on this later in the write-up.
On the same call, management indicated they are open to selling the company and recent transactions support a much higher valuation (FlyOnTheWall reported there was rumored interest from Mercury Systems in May of this year). The founder and CEO owns almost 10% of the company and he is 78 years old, the Chairman of the Board is 80, another President is 75, and of the remaining two directors on the board, one is 86 and the other is 78. The company recently transformed earnings power by adding manufacturing capacity to support a new product slate and with the business on the tipping point, I suspect a couple contract wins will light the way to an exit from the public market.
I think the growth path commands a 10x multiple on EBITDA and on ~$14mm in EBITDA this year that implies a ~$17 stock price. Microsemi’s acquisition of Symmetriciom at over 14x EBITDA also supports this multiple yet a $17 target equates to only about ~8x a conservative estimate of what FEIM could earn in EBITDA next year. The valuation is even more appealing considering the potential for a transaction (divestiture to pad the B/S with additional cash or potential sale of the company).
Why does the opportunity exist?
I think the opportunity exists because this is an unknown, illiquid micro-cap company without any coverage. Sidoti used to cover it but in their IPO push the analyst was seemingly pressured to abandon it and he dropped coverage last week. The analyst actually really liked the stock, knew the name really well and kept tabs on the industry rags like Space News. He was forecasting ~$14mm of EBITDA this year (vs. what should be ~$7.8mm this past year), but I think his numbers were very conservative. His estimate was based on roughly $10mm in incremental revenue yoy but a single contract win could provide run-rate revenue expansion of $20-40mm and the company is targeting 2-4 contracts per year beginning now and three are currently in negotiations. I think it’s likely they blow through his estimates but he didn’t want to look silly with a huge number out there. Below is a quote from the CEO, Martin Bloch, on the F3Q’15 earnings call….
“…we are right now negotiating contracts on three satellites to do the basic development, and we hope to conclude this negotiation before the end of March…the proposal that we have outstanding addresses our existing product line, plus our new products, especially the Ku, Ka band up/down converters and those specialized synthesizers for the Earth-orbiting environment.”
The “basic development” amounts to $5-10mm in revenue per satellie, while the up/down converters amount to $20-40mm. They should win the basic stuff without a problem and if they convert on the rest, well, numbers will be huge.
Bullet Point Thesis
FEIM will earn around $80mm in revenue this year but they are on the brink of earning new contract work that will expand revenue to well over $100mm and lead to a ramp in EBITDA.
FEIM has evolved from earning about $1mm per satellite to more recently earning about $5-10mm per satellite following an upgrade cycle where they won more content per satellite. We are now entering a new upgrade cycle.
Taking more share of the component bill for each satellite is largely the result of the government's shift away from cost-plus contracts and towards more fixed-price work. When this happens, the Boeing’s of the world subcontract out more work to companies like FEIM who specialize in certain components and can manufacture high quality components for a lower price due to their specialized focus on these products.
FEIM will begin earning $20-40mm in revenue per satellite by selling a new set of products (up/down converters). Large manufactures have been waiting for FEIM to build the capacity to take on this new business and after over a year of investing in capacity expansion, product testing, product qualifications, etc., FEIM is finally ready to take on contracts and they have entered negotiations with three customers.
In addition there is a double-digit revenue opportunity for Earth Orbiting military satellites that could add to revenue growth (>$10mm opportunity)
The only analyst that covered the stock was modelling ~$10mm of top-line growth and on this highly conservative estimate he arrived at EBITDA of ~$14mm this fiscal year. I suspect they will beat this number but at 10x (and ~8x next year), the stock is worth $17 vs. where it trades today at ~$11. (Symmetricom deal was at 14x)
In addition, they have two other wild card opportunities that could be material, they may sell a division to add additional cash to their net cash position, and the 78 year old CEO has stated they are open to selling the company.
Finally, there are two other wild card opportunities in there other segments but I don’t include these in my analysis and leave them out of my thesis. Success with either one could be a substantial driver of earnings, though.
Background in Detail
Frequency was founded and incorporated in NY in 1961 by Martin Bloch, the current CEO and a Director on the Board. Bloch worked for seven years during the 1950s for watchmaker Bulova, where as chief electronics engineer he was heavily involved in the development of the world’s first electronic watch. He founded Frequency when he was 25 years old and won a Naval Research Lab contract which buoyed the company until they gathered enough business to become sustainable. Envisioning timing would become a key ingredient of future technology, he focused on timing and atomic clocks.
By the 1980’s the military was using Frequency’s products for navigational purposes, guidance systems, encryption needs and radar warning systems on fighter aircraft. Around the same time Frequency established an alliance with TRW, acting as a subcontractor on satellites built for the U.S. government. In ’87 FEI bought a TRW unit, TRW Microwave, paying about $17mm. The acquisition was the start of a shift away from dependence on business from the DOD and an effort to fill the need for private-sector satellite hardware as well as ground-based communications systems.
Today the company is the premier manufacturer of precision quartz and atomic clocks to commercial and military satellite programs (over 6,000 assemblies flying). They operate under three reportable segments based on the geographic locations of the subsidiaries but the primary business is satellite technology.
FEI- NY – operates out of New York and its operations consist principally of precision time and frequency control products used in three principal markets- communication satellites (both commercial and U.S. Government- funded); terrestrial cellular telephone or other ground based telecommunication stations, and other components and systems for the U.S. military.
The FEI- NY segment also includes the operations of the Company’s wholly- owned subsidiaries, FEI- Elcom and FEI- Asia. FEI- Asia functions as a manufacturing facility for the FEI- NY segment with minimal sales to outside customers. FEI- Elcom, in addition to its own product line, provides design and technical support for the FEI- NY segment’s satellite business.
FEIM had a stake in Elcom until they acquired the entire company in February 2012 (bought the 75% they didn’t own for an additional $7mm). Elcom brought Frequency technology in high frequency microwave devices and subsystems. Combined with Frequency, the addressable market for Elcom’s products expanded to include multiple new opportunities in Electronic Warfare, Signal Intelligence and other applications in Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (“C4ISR”). Elcom’s technology was integrated with FEIs technology to address higher dollar value applications for products.
Gillam- FEI - operates out of Belgium and France and primarily sells wireline synchronization and network management systems in non- U.S. markets. All sales from Gillam- FEI to the United States are to other segments of the Company (this is the remote terminal unit, or RTU business they talk about on calls)
FEI- Zyfer – operates out of California and its products incorporate Global Positioning System (GPS) technologies into systems and subsystems for secure communications, both government and commercial, and other locator applications. This segment also provides sales and support for the Company’s wireline telecommunications family of products, including US5G, which are sold in the United States market.
An overview of segment level earnings, which are lumpy, are below.
The company cites one longer-term and two near-term opportunities that will drive substantial revenue growth. On the long-term side they expect slow but steady rollouts of Remote Terminal Units (RTUs); basically smart meters. On the short-term side they identify primary growth drivers as (i) GPS upgrades, i.e. secure communications and (ii) Satellite Payloads, i.e. more component sales into Satellites (backlog is mostly related to Satellite Payload projects).
The satellite piece is broken into two pieces, the first being multi-function communication satellites that cost anywhere between $200mm to $1B and the second being small earth-orbiting satellites.
I think the real near-term opportunity going forward is within the space satellite business because (i) the GPS business addresses issues that have been well known to exist for quite some time now and yet they remain unaddressed by both government and DoD, so I’m not sure what will all the sudden drive adoption here...i think this can just keeps getting kicked down the road so i basically ignore this optionality; (ii) the small earth-orbiting satellites don’t require the expensive equipment the multi-function communication satellites do, so there are fewer margin dollars available here (this will drive growth, and on last call Martin indicated this is a double digit revenue opportunity, so over >$10mm at least, but it’s not the primary revenue driver).
So in terms of earnings drivers and probability of occurrence, I think we see project wins on the space satellite side drive top-line before we see significant growth in these other areas. The space sat wins will primarily flow through the FEI-NY business, which has been a steady grower in recent years on the heels of Frequency continuing to win a larger share of the components that go into a satellite.
Space Satellite Business
In 2005, when FEIM was mostly known as a commercial telecommunications company, the satellite business only accounted for about $5.5mm of total revenue whereas today it accounts for north of $40mm and growing. The growth has not been unexpected. Since the 2009 shareholder letter, management has laid out a clear path and has consistently forecast their position with decent accuracy. I bring this up because I think it lends them noteworthy credibility. (I’ve tried to paste in a slide below but if it doesn’t work, see slide 22 of their January 2015 presentation from the Needham Growth Conference)