Southwall makes coatings for automotive and architectural glass. The coatings do things such as reduce heat form light that makes it way through the glass and other doodads that make it environmentally friendly. Less heat making its way into the car via sunlight will reduce the need for gas guzzling A/C, and the similar principle applies to homes as well. This is the kind of product, assuming the company is already profitable, that one might be drawn to invest in for the upside potential from any legislation regarding more environmentally stringent building codes or the increasing fuel economy mandated by governments. The company is profitable, but not nearly to the degree that a quick glance would reveal, making the company's future more of a pleasant narrative than an investment opportunity.
Using fully diluted shares, the company still trades at 9 times TTM earnings, so it would appear that the company is trading at a price that offers some downside protection in relation to its earnings. This first thing I noticed when I looked at the income statement was that 2010 benefiting from a $3.6m tax benefit, a non-recurring charge. Even taking away the benefit of a tax benefit, the company earned the most in 2010 going back 10 years. This is not the earnings profile of a fat pitch investment.
While that alone is a pretty plain vanilla reason one would normally attribute to passing on a stock, I decided to write about Southwall because there are some other reasons I would avoid it even if you believed that its future markets will be booming.
The company just listed its shares on the Nasdaq, moving from the OTC market. I think the Nasdaq listing requires a closer look. It will increase liquidity as a larger pool of capital will be able to buy and sell the stock. It begs the question why the company now seeks liquidity. The answer is in the form of a controlling investor through shares and convertible preferred stock that is well in the money hoping to cash out. This will increase share count by 25% when converted.
The company has a history of dilution, with fully diluted shares in 2001 at 1.6m all the way up to 7.2m in 2010. While book value has increased at quite a rapid rate, the book value per share has grown at a much slower pace. This is a sign to stay away.
Needham & Co. owns 60% of the firm assuming conversion of the convertibles. I think the Nasdaq listing is going to give them an opportunity to cash out. While the shares trade for $11.50, their cost is much lower and the conversion price on the converts is $5. I think the listing is only to give them liquidity to offload their stake. Even if I'm wrong, this dilution and historical dilution don't give me confidence that current shareholder's will get their fair share of future rewards.
Another cause for concern is that since 2004, the company has had an agreement with another company that was responsible for 38% of revenue in 2010. This agreement ends in 2011. Additionally, the company’s customers are comprised of mostly larger glass makers that are likely far less dependent on Southwall than Southwall is on them. Their top 4 customers accounted for 74% of the company’s sales.
In short, buyers beware. I wouldn’t be surprised to see some speculative activity in the stock as some people might neglect some of the company’s warts in hopes that greater upside lies in the “green” image the company could adopt. This is where investors differ, as they would look to the downside and find that it exists. This stock was an easy pass just from seeing that 2010 earnings (from which the PE is calculated) were an outlier, but even absent that I would be skeptical that Southwall would be a worthwhile investment opportunity.
Posting has been light lately because I've been debating how much effort I should put into talking about stocks I don't buy. Ultimately, I've decided its worth doing because I think it is a valuable teaching tool, forces me to articulate why I'm not buying a stock, and maybe someone will email me with an opposing view.
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