Nu Horizons Electronics Corp. NUHC
December 23, 2008 - 4:11pm EST by
ithan912
2008 2009
Price: 1.16 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 21 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

Investment Thesis
 

Nu Horizons Electronic Corp. (“NUHC”) is a Nasdaq listed distributor of technology products, based out of Melville, NY. This long thesis is based upon several things: 1) valuation absurd, 2) history of profitability or breakeven throughout cycles, 3) margin improvement, 4) large insider ownership and 5) large seller done selling.

I believe the stock should trade at least at liquidation value, somewhere between .7-.8x tangible book, in this environment given solid working capital management, A/R and inventory turns of 6x per annum with obsolescence agreements, and guesstimate of $10mm in shutdown costs.   Obviously it can trade much higher than liquidation value when it’s earnings stream is valued in a more stable equities environment. Tangible book as of 9/30/08 was $141mm or $7.75/share. Yes that is a lot of upside and yes there are tons of small cap businesses trading at seemingly ludicrous valuations. I believe this upside exists with very little downside however. 
 
Business
 

NUHC distributes active and passive electronic components to OEMs of electronic products. These include memory semis, computer processors, digital and linear circuits, microwave/RF and fiberoptic components. Passive components mainly are capacitors, resistors, and inductors. NUHC claims to work with over 9000 OEMs. 10% of its business is Systems and is basically distribution of Sun and IBM servers and storage components and software to OEMs. 

NUHC has increased its focus in Europe and Asia through acquisitions and greenfield offices to take advantage of the wave in production movement to Asia. Its business is doing quite well there based on 08 results to date with 50% growth YoY. Europe is struggling more given weak economic conditions but they still managed 9% YoY growth in Europe YTD. 

The last acquisition completed was for $3.5mm in Sept 08 and management is done with acquisitions for the foreseeable future and wishes to integrate the deals they have done over the last 2 years and focus on improving margins and profitability. Costs should come down and margins improve as they reduce SG&A, reduce low margin products and allow the recent design wins to take their course. Last quarter did see some gross margin erosion as they sold off low margin inventory and Asia business improved as total % of sales but this should return to normal 15%+ GM. Most margin improvement going forward will be at the SG&A line given reduced Vitesse legal costs starting next year (see Vitesse section).

They will not provide guidance for a while until economic conditions improve and they get better color from OEMs. Management is very proud of their OEM relationships however and they feel NUHC is critical for many of them given NUHC’s history and understand of OEM technology and the supply chain. 

The tables below from the last 10Q provide a summary of sales for the Company for the three and six months ended August 31, 2008 and 2007:

Analysis of Sales from last 10-Q

Quarters Ended August 31,

Percentage

Change

2008

% of Total

2007

% of Total

2008 to 2007

Sales by Type:

Electronic Components

$

185,502,000

88

%  

$

173,543,000

94

%  

7

%

Systems

26,311,000

12

%

11,826,000

6

%

122

%

$

211,813,000

100

%

$

185,369,000

100

%

14

%

Six Months Ended August 31,

Percentage

Change

2008

 % of Total

2007

% of Total

2008 to 2007

Sales by Type:

Electronic Components

$

371,424,000

90

%  

$

335,657,000

93

%  

11

%

Systems

40,541,000

10

%

24,944,000

7

%

63

%

$

411,965,000

100

%

$

360,601,000

100

%

14

%

 

Insider ownership
 
Arthur Nadata, CEO & Chairman owns 444k shares and Richard Schuster, President & COO, owns 420k shares, collectively 4.75% of shares outstanding. Given their ownership has fallen 80% YTD, or $5mm, their focus on shareholder value has been enhanced no doubt.   

 
Balance Sheet/Liquidity
 

On top of everyone’s mind is balance sheet and associated leverage, especially for a low margin business like NUHC. I believe the technology distribution business is not doomed nor in secular decline, yet I make no assertions that it is a great high return business. It has certainly proven otherwise over the years. This thesis is more of a Ben Graham thesis than a Buffet thesis. 

As of last week, there were no covenant issues with their credit facilities - cash, free cash flow and facility availability are more than adequate for the next 12 months per the last 10Q and management comments. Management is on top of this and aware of the poor financing environment and has no interest in refinancing or having to negotiate with banks. In addition, no further acquisitions are on the radar. 

There are 3 credit facilities, separated purely by region. $150mm available in the US at LIBOR + 175 or at bank’s prime rate, at NUHC’s discretion. 8 banks back this line and it had $61.2mm outstanding as of 8/31/08. In Europe, they have a 2.5mm pound line with a bank in England at base rate + 165bps. It is near fully committed as of 8/31/08. In Asia, they have a $30mm secured line by Asia assets at SIBOR + 150bps. Current borrowings are $5mm as of 8/31/08. 

As of 8/31/08 there was $56mm available under the 3 facilities.

The A/R is in good shape and inline with historical trends as their top 10 customers (Xilinx, IDT, Linear Tech, Sun Micro, STM Micro, Marvell, Vitesse, Finisar, MSC) are all current and pretty good credits in tech land. In terms of inventory concerns, they are greatly evaded by the fact that more than 90% of the inventory is covered by obsolescence agreements with suppliers whereby NUHC can return slow moving or obsolete inventory. Given 6 turns per annum this has not historically been an issue anyhow.

 
Vitesse legal matter
 

From the latest 2Q 10-Q:

The Company is continuing to cooperate with the inquiry by the Securities and Exchange Commission ("SEC") and to conduct its own related internal investigation under the direction of the Audit Committee in the action captioned "In the Matter of Vitesse Semiconductor Corp." (referred to herein as the "Vitesse Matter"). The cost related to the SEC investigation and the internal investigation has required the Company to incur significant expenses for professional fees and related expenses. For the three- and six-month periods ended August 31, 2008, the Company has incurred approximately $1,671,000 and $2,333,000 for professional fees compared to $382,000 and $520,000 respectively, for the three- and six-month periods ended August 31, 2007. Cumulatively, $5,000,000 of expense for professional fees has been incurred to date since fiscal 2007 related to the Vitesse Matter. Management is presently unable to determine the duration of the SEC inquiry and related cost to be incurred by the Company. However, management believes that the Audit Committee's internal investigation is nearing completion and, consequently, expects total monthly costs to decline by the end of fiscal 2009.

On or about October 4, 2007, a Consolidated Amended Class Action Complaint for Securities Fraud (“Amended Complaint”) was filed in the United States District Court for the District of California in the matter entitled Louis Grasso, individually and on behalf of all others similarly situated, Plaintiff, v. Vitesse Semiconductor Corporation, Louis Tomasetta, Yatin Mody, Eugene F. Hovanec, Silicon Valley Bank, Nu Horizons Electronics Corp, Titan Supply Chain Services, Corp. (Formerly Known as Titan Logistics Corp.), and KPMG LLP, Defendants. Pursuant to the Amended Complaint, Nu Horizons, Titan, Silicon Valley Bank, and KPMG LLP were added as defendants to the putative class action which had been commenced by certain purchasers of Vitesse common stock. In the Amended Complaint, plaintiff alleges that Nu Horizons and Titan violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder and seeks rescission or unspecified damages on behalf of a purported class which purchased Vitesse common stock during the period from January 27, 2003 to and including April 27, 2006. As of February 29, 2008, a class has not been certified. The complaint against Nu Horizons was dismissed with prejudice. The plaintiffs have not determined whether they will appeal that ruling. Nu Horizons will vigorously defend any such appeal.

Pretty self-explanatory on the cost impact and future expected savings on legal costs. However, according to management last week, this issue has been a major distraction and although they won't guarantee anything, it should result in limited further financial impact.
 
Valuation
 
Clearly the equity is very cheap if you believe in Graham’s net-nets. In addition, using EV/Rev and P/TBV NUHC is well below the 2 large comps, Arrow and Avnet. Both ARW and AVT have been acquisitive of distributors and aren’t afraid to take advantage of cyclical downturns to grow their market share.  I would expect an acquisition of NUHC would be highly accretive up to $10/share and NUHC’s Asia growth and exposure to PLD/communication semiconductors should be attractive. There is also the possibility that the current management team may be able to go private once financing is available to them for such activities. Either way, I have no problem playing catcher’s mitt for large sellers who are agitated by the company’s recent stock and earnings performance. Sometimes selling just begets selling and I believe this to be the case with NUHC. Please see below comp chart.

Large sellers
 
 
Wasatch, Oppenheimer and Deutsche appear to have thrown in the towel and have been exiting their positions, causing severe pressure on the stock. For people new to the story and not suffering from behavioral finance issues, it is an opportunity. NUHC has recently hired Connie Chandler to run IR. Although sweet and experienced in IR, it remains to be seen how much impact she will have and how her seemingly mediocre understanding of the business will generate investor interest. 
 

Risks

-         Not able to control costs inline with further revenue decline
-         Customer specific credit issues affecting receivables
-         Micro cap and associated weak liquidity
-    Time for market to get interested in this microcap business, or an acquisition to occur to maximize value. 

Catalyst

- margin improvement
- debt paydown
- positive SEC/Vitesse result
- acquisition at substantial premium
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