Infosonics IFON
February 16, 2011 - 12:41pm EST by
surf1680
2011 2012
Price: 0.92 EPS $0.00 $0.00
Shares Out. (in M): 14 P/E 0.0x 0.0x
Market Cap (in $M): 13 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): -3 TEV/EBIT 0.0x 0.0x

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Description

Given all the excitement about Nokia and Microsoft teaming up to take on Google and Apple, how would you like a ground floor opportunity to invest in a new, Android-based line of smart phones being sold in emerging markets by an industry veteran who is putting his own money on the line?


IFON is trading at less than cash value. They had a major tariff change in one of their core markets and are making their way through a major transition to a new business model in completely new markets. After many years of only being a distributor of phones in Latin America, they started developing their own handsets and are selling them in the Asia-Pacific region. They identified new markets they wanted to serve. They harnessed recent developments in open-source operating systems, plentiful cell phone chipsets, and Chinese engineering talent. They designed and developed a smart-phone that they think will do well in their specific new markets... And, they have 2 of these new handsets actually shipping.  Meanwhile, the stock market attributes no value to their future prospects. Sales results from the new phones are not out yet but promotional activity is available and it appears exciting.


To summarize, here is why this stock should at least be a small part of your portfolio:

1.  Valuation - Even if their new company strategy eventually goes down in history as a flop, sometime in the next year the market might at least change their perception of the company from dead to *anything* other than dead (comatose would be a nice improvement). If you look at their most recent quarterly report, the drop in revenue is startling. Mr. Market is likely still recovering from that shock. If Mr. Market even senses a hint of future profitability then the stock should trade at above cash value, which is a 30% upside.

2.  Incentivized Manager - The CEO is in a unique, shareholder-friendly situation. Unlike managers of most cash-rich firms this CEO is perfectly incentivized. He could personally lose over $5 million if the company fails. He can walk away to avoid that loss but he apparently is not (so far).

3. Technicals - The stock is exhibiting technical features that make some investors inclined to sell or avoid.  They've received numerous alerts from Nasdaq that their share price is too low. It could be delisted. Some funds have to sell penny-stocks and some funds can't touch penny-stocks.


Product analysis

IFON's new smart phone handset uses Android OS and a chipset from Korea. They conceived of the phone in San Diego and hired slave-labor engineers in Beijing to do the integration. The phone just shipped to Asia in October and Indian in January. From what I can tell, it is being aggressively marketed (at least on the websites) by a major player, Videocon, in India. It appears to be co-branded by Ducati Motorcycles, as well. It is a “tough” style, smart phone. It has some novel features like a thermometer, barometer and a flashlight. It is the only phone I could find with those features. You might think such features are ridiculous or silly by western standards, but I noticed that having an FM radio in your cell phone is a hot commodity in India (many Nokia phones have this feature), and, I personally noticed how susceptible to gadget gimmickry my Chinese classmates were (I studied Japanese in Tokyo and all my classmates were from rural Chinese towns, the phone they envied the most was a cheezy handset with an analog TV receiver and a silver telescoping antenna, not so much interest in an iPhone!). So, before you prejudge them on how ridiculous it might be to have a flashlight in your cell phone, remember - there is no accounting for taste. Their new product genuinely has some unique features – search for a cell phone with a thermometer and their handset comes up as the only one in India.

How could a tiny company with minimal R&D history develop a feature-rich smart phone? Aren't those things complicated? The answer from the CFO is that engineering & integration talent in China costs 1/10th of what it costs here, and the other part of the answer is anecdotal from a friend who works at Qualcomm. He says Qualcomm is increasingly spending more money and engineering resources to make it easy for others to integrate chipsets. My engineer friend works for whoever buys the Qualcomm chips. Lastly, Google makes this Android open source OS specifically to make integration standardized, cheaper and easier. So I guess if you're not pushing the envelope too much then it can be possible to produce your own smart phone (with a barometer in it, no less) for not much money. According to their financial reports, they only put up $1 million to fund the first 2 handsets. They are on the hook for another million and there is some profit sharing to their investment. All I can get from the cfo regarding expected margins is that they'll be better than ever before (previous business was a low margin distribution business – easy to improve upon).


Here are some websites that show their products and marketing in India. The second phone in the presentation on Videocon, “the Mo-Biking,” is the VeryKool R80 (VeryKool is IFON).

http://www.videoconmobiles.com/


Here's the VeryKool site. Most of the phones with exception of the r80 and the S810 are just phones they distribute:

http://www.verykool.net/Phones/r80/


Here's one already on eBay India:

http://cgi.ebay.in/VIDEOCON-6200-Rugged-Sports-Design-Powered-Ducati-/220737604226?pt=IN_Mobile_Phones&hash=item3364fc8a82#ht_2603wt_754


Incentives: The CEO's situation.

The plight of the common man - a simple choice: (1) go to work, earn a paycheck, plus maybe a bonus. Or, (2) quit your job and go do something else. If you quit, you receive no salary and no chance for a bonus.

The situation for the CEO of IFON is different. Instead of quit-option #2, the CEO can quit the job and receive $5.5 million cash almost immediately. If he doesn’t quit, and he fails at his job, he could lose that $5.5 million. He’s young enough that he might even be able to get a nice job somewhere else. His choice every morning becomes (1) go to work, earn a paycheck and hopefully receive some big payoff bonus in the future, or (2) quit the job, take nearly 15 years of salary upfront, and go sit on a beach, get another job, etc. Given these choices, you would only stay in the job if you had high expectations about that bonus. His bonus will come when the market attributes some value to his business... personally, ANY value is all I'm looking for. Keep in mind, the $5.5 million he could get if he walks is not the current market value of the shares he owns but his due portion of just the cash in a liquidation of the company.


Net tangible book value per share: $1.55

Net cash per share: $1.21

CEO owns 31% of shares = 4.6 million shares.

Thus, if they liquidated, his portion of just the cash would be $5.5 million.

For the record, his salary is $367k. It would take 15 years to net $5.5 million.


This is a barebones company with few encroachments on that cash. I verified with the CFO that all the numbers on the 9/30/2010 balance sheet are good approximations to being realizable. They lease their offices and the terms are short. They have, worst-case scenario, about $700k in offshore taxes/forex issues. They don't have much inventory and the receivables are from large, multinationals.

The CFO was talkative on the phone but he didn't invite me to visit their headquarters. I dropped by anyway. It seemed like not much was going on. Golf clubs were permanently stored behind the receptionist's desk (no receptionist). There was a “for lease” sign in front of the building (but they only occupy 1/8th of the building so it could've been for other space). The lights were on but not many were home. It looks like an office in transition. I saw an employee who looked like he was part Indian. How's that for sleuthing?


Risks:

     

    The valuation as a dead company plus the CEO's incentive is what attracted me to this idea. It could be that $5.5 million isn't that big of a deal for him and/or that he has his ego tied up in the company. He could let the cash burn while he tries new strategies, over and over again. Since their IPO in 1994, the company has tried different strategies, and turned in some good years (and the CEO has cashed in multiple times when the valuation was steep).

     

Catalyst


  1. New strategy & products gain some traction and provide encouragement to Mr. Market.  Mr. Market recovers from seeing revenue drop like a rock.

  2. The company starts to promote their strategy and products like they used to promote past strategy.

  3. Return to profitability


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