From the end of March 2015, I accumulated a position in Microwave Vision¹. At the end of April, management released the 2014 results. To make it clear the numbers have been disappointing.
Good summaries of the company’s 2014 analyst presentation have been published here and here. An interview with Philippe Garreau about the results and the perspective of the company can be found here. After the release of the results, I spoke to management and the following is my assessment of the current situation:
Let’s have a look at the accrual numbers first. Revenues increased by 10% to EUR 56.7 m. EBITDA before non-recurring items reached EUR 7.0 m or 12% of revenues and increased by 26% y-o-y. Hence, in addition to top line growth cost reductions had a positive effect. However, this is only part of the story. Taking into account an increase in provisions and D&A by EUR 0.8 m to EUR 2.1 m as well as non-recurring costs for litigation, restructuring of two plants (San Diego and Manchester) and severance payments (together roughly EUR 0.9 m), EBIT decreased by 4% y-o-y to EUR 4.0 m. A relative increase in taxes and higher finance costs lead to a decline of net profit by 20% y-o-y to EUR 2.4 m.
The increase in provisions is related to an increase in business activity in the US compared to 2013. Amortisation increased due to a new software implemented in 2013. Management expects settlement negotiations to start within the first half of 2015 regarding a potential patent infringement by the competitor ETS Lindgren. Finance costs increased by EUR 0.3 m. This is unfortunate given that MVG has a net cash position of EUR 21 m in place.
In my original analysis, I pointed out that cash conversion in 2013 was quite slow. Unfortunately, this trend accelerated in 2014. Operating cash flow decreased from EUR 1.6 m in 2013 to EUR -0.3 m in 2014. Changes in working capital negatively impacted operating cash flow by EUR 6.7 m. Receivables further increased by 18% to EUR 30.7 m compared to a 10% increase in revenues.
According to management, the major reason for slow payment collection comes from China (roughly 20% of revenues) where intermediaries have been waiting for VAT reimbursement from the government before paying their bills to MVG, clients not being ready to receive the finished products from MVG and “good” clients asking for a technology update before paying their bills to MVG. In addition, payment delays due to a damage concerning a large product order in the US and some clients delaying payments in Europe led to the relatively high increase in working capital. Nevertheless, this is not a short term effect, but a structural issue with this company. In the aerospace/defence sector the largest part of the payment is received once the finished good is delivered and operational. However, this depends on whether the client is ready to install the product. In the telecommunication segment payment collection seems to be faster, but here MVG faces strong competition from ETS Lindgren which leads to price competition despite MVG’s superior products. As a consequence, though management seems to be committed to improve cash collection going forward, keeping the current ratio of working capital relative to total assets would already be a success from my point of view. This is also due to management’s focus on increasing top line growth.
Management also reported that they were in advanced negotiations regarding the takeover of an European target. However, in the third quarter 2014, the acquisition candidate started to face a number of problems concerning profitability. As a consequence, management stepped back from the deal. Though this is a set back with regard to the allocation of the proceeds from last year’s capital increase, I have respect for management’s decision. It is not easy to opt against an acquisition after having spent a lot of time and resources on it.
In my original write up, I mentioned that MVG should profit from the rising USD. This is only half right. Certainly, the strong USD makes MVG more competitive relative to its US peers. However, from a geographical point of view most of the cost base is equally split between France and Israel. As the Israeli Shekel is most of the time moving in line with the USD, currency fluctuations have only a small impact on the company’s cost base.
Overall, I was overconfident that the cash conversion cycle had been reduced in 2014. Something I have no control of and which was a speculation from my side. In hindsight, I should have waited for the release of the 2014 results before making my investment decision. At the time of writing this update, my impatience has cost me roughly 10% of my investment.
From my perspective, the downside risk of this investment is stemming from a potential write off of uncollectable receivables or some accounting issues arising for instance at Orbit/Fr in the future. According to management, while delayed payments have been an issue for years, payments were collected at some point in time for the vast majority of the contracts.
I believe that the current stock price is reflecting most of the uncertainties. Following management’s presentation of EBITDA for 2014, the company is now trading for an enterprise value to EBITDA multiple of 4.8x. If management is able to execute on the external growth opportunities and improve operating cash flow in 2015, I believe that the stock price will re-rate substantially.
Nevertheless, from today on I will reduce my allocation to a 2% position. Reason for that is management’s incapability to provide for sustainable growth (reflected in the cash flow statement) over the last two years.
1) From March 30th 2015 until April 23th 2015 I bought a 3% position for the portfolio at a share price of EUR 9.86 based on the VWAP under the assumption that I trade one third of daily volume.
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