Neo Material Technologies vs. Pala Investments

I discussed Neo Material in a previous post in which I mentioned how Pala Investments was making a bid for about 20% of the shares outstanding of Neo at $1.40/share.  Neo's Board responded by amending its poison pill to stop what it sees as an opportunistic offer that undervalues Neo massively.  Pala press released that it disagrees with the "knee-jerk" reaction of the Board and that shareholders should be allowed to decide for themselves with regard to accepting or rejecting the offer at $1.40.  If the offer is accepted, Pala would own about 40% of Neo.

I think it is worth asking if your interests as a small shareholder are necessarily aligned with that of a large shareholder such as Pala Investments.  If you think that $1.40 is solid value for the company, then the answer is obvious.  On the other hand, if you think that $1.40 is a large discount to the true value of the company, should you welcome Pala and look forward to having more of the shares owned by a "strong long-term investor"?  Here is a little story.

In May 2008, JMI Equity and The Carlyle Group offered to buy all of the shares outstanding of Gemcom Software International.  Pala Investments was a large shareholder of Gemcom (owning about 20% of the shares).  Pretty simple takeover offer;  well, there is one more twist in this story.  In July 2008, we learned that the offer was increased but that Pala Investments was now part of the buying group, partnering with JMI Equity and The Carlyle Group to buy Gemcom.  The bid was successful and Gemcom is now a private company.  

I do not know if Gemcom shareholders got solid value for their company.  I do not know if Pala helped shareholders get a better price for the company.  What I know is that Pala can buy companies and take them private and as such, Pala is not necessarily aligned with the interest of small shareholders.

If you were a shareholder of Neo Material, would you want to see Pala Investments own 40% of your company?  Do you agree with the Board of Neo Material Technologies?  Let me know.

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Note:  Once again, do your own due diligence.

Update: Ruggedcom a Smart Grid Company

Ruggedcom (ticker: RCM in Toronto) was the first company I discussed on this blog. The company reported its third quarter financial results last night and had a conference call this morning. Overall, the results were impressive.

• Revenues were up 53.4%.
• Consensus was expecting earnings per share of $.21 and the company reported $.033.
• Gross margin was up strongly to 65.7% due to improved product costs, favorable sales mix and foreign exchange.
• The company generated cash once again. The cash on the balance sheet declined slightly but it was a foreign exchange effect.

A few things to consider. In the past few weeks, this company has been hyped on television or in newspapers by a number of "experts". Hype can be a problem, especially for companies with volatile quarterly results. One weak quarter and all the "fast" money would want to exit at the same time. It is a problem but it can also create a buying opportunity. One last tidbit, I would not be surprised if one day Cisco buys Ruggedcom. Keep this one on you radar screen.

"Attractive": Neo Material Technologies

In keeping with my philosophy of investing only in "good" companies with strong balance sheet and solid free cash flow generation, I came up with Neo Material Technologies (ticker: NEM in Toronto, market cap of $149 million @ $1.22/share). Their website is here. Neo is a producer of high-quality rare earth and magnetic powders that are essential in the manufacture of many high-tech products.

The company is an intermediary between the mining company and the manufacturers. It buys rare earths mineral concentrates in China and separates the individual elements, which are then sold. Some of the processes used by Neo are protected by patents (expiring in 2014) and as such, the company enjoys a very high market share in some of its markets. For example, the company sells 80% of the "neo powders" sold worldwide. Neo powder is used to make very strong magnets. Neo's products are essential to the manufacture of various high tech products including: micro motors, computers, optical lenses, mobile phones, display panels and electronic chips. Some of Neo's clients include: Daido, Epson, Panasonic, Hitachi, BASF, Philips, Samsung, Canon, and 3M. Not bad for a small company.

Why invest in rare earths? Rare earths are part of the Minor Metals group, which got its name from the fact that these metals were initially considered of minor industrial importance as compared to Major Metals (iron, lead, copper, etc.). I believe that we have entered a new age: the Age of the Minor Metals. We went through the Stone Age, the Bronze Age, the Iron Age and now we are in the Age of the Minor Metals. Minor metals are essential to our high tech world. While the quantity of minor metals produced will be dwarfed by the quantity of copper, zinc, .... produced , the importance of minor metals should not be underestimated. No minor metals = no iPhone and no flat screen TV.

I believe that, while the cyclical forces currently affecting the global economy will hurt Neo, the secular trend is for continued growth. As such, the current environment could enable us to get a good company at a great price.

At the end of the last reported quarter, Neo had a net cash position of about $32 million (that's $0.27 per share on a fully diluted basis) and the company was generating cash from its operations. In the last 4 quarters, the company reported earnings of $0.30/share and as such, it is trading at 3x to 4x trailing EPS, depending on how you adjust for the net cash. This does not look very expensive but earnings will likely be lower going forward due to the recession. So in the short term, Neo's financial results should be less than inspiring, however, this represents an opportunity for investors with a longer term view.

One of the risks with Neo is that the company relies on Chinese mining companies for its concentrates. China dominates the world's production of rare earths and therefore, it is not surprising that Neo uses Chinese suppliers. As Chinese internal demand for rare earths increases, it is possible that the Chinese government will erect export barriers, making more difficult for Neo to supply its clients. It is something to watch.

Of note, Pala Investments, owner of about 20% of Neo's share outstanding, has announced its intention to bid for up to 23 million Neo shares (representing about 20% of shares outstanding) at $1.40. For the flippers out there, you can buy Neo today at $1.22 and sell your shares to Pala Investments for $1.40 for a quick 15% profit. Sounds good but there is a risk. Neo has a poison pill provision, which states that 50% of the independent shares must be tendered in order for the proposed bid to proceed. Pala has asked Neo's Board of Directors to waive this provision to allow the bid to proceed. I have not insight on what the Board will do but if it waives the provision, the shares should climb quickly to near $1.40 while if the provision is not waived, the stock could go down to where it was before the bid, which is below $1.10.

Pala, a long term investor in Neo, sees value in the company and is, in my view, being opportunistic. As a long term investor, I also see value in Neo and I think that 2009 should offer a very attractive entry point.

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Note: Do your own due dilligence. I am Evil.

The Aftermath of Financial Crises

Every day, we hear about a new prediction on the length and severity of the current recession. I believe that, while history does not repeat itself, it can be a very useful guide. I have found this paper called "The Aftermath of Financial Crises" that presents a historical analysis of other banking crises in advanced economies since World War II. It is an easy read and is well worth the time it takes to review it. Overall, it appears that we are still in the early innings of the crisis. Here is one of the graphs in the report.

Riding the Wave - Ruggedcom Inc. (Ticker: RCM in Toronto)

Have you heard of The American Recovery and Reinvestment Act of 2009? In the next few weeks, the U.S. Congress will consider this Act, which could have very positive effects on a few small cap companies with exposure to the U.S. market. One of them is Ruggedcom. The focus of the Act is to modernize the U.S. infrastructure, including creating a smart grid. Ruggedcom has designed products and technologies that are the communications backbone of the smart grid and the company has been successfully selling to electric utilities for past few years. I could go on and on about the various products offered by Ruggedcom but I think the best way to educate yourself is to visit their website (http://www.ruggedcom.com/).

Ruggedcom has been riding a wave of investment in rugged communications. Last quarter, its revenue was up 54% year-over-year and 13% quarter-over-quarter, with most of the growth coming from sales to electric utilities. The other segments (Transportation, Industrial and Military) have also shown some limited growth.

(Click picture to enlarge)

Profitability has also exhibited strong growth but with some volatility. This volatility in earnings could potentially provide an entry point into the stock if the company were to report a "bad" quarter.

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In addition to the fact the Ruggedcom is in a good industry to benefit from infrastructure investments, I also like the company because it does not need financing. Ruggedcom has over US$45 million (that's US$3.60 per share) on its balance sheet with no debt and it is generating cash. So the company has staying power.

For the fiscal year ending in March 2009, the consensus estimate is around US$.82. The shares are trading at around $14.50 putting the P/E multiple at 17.6x or 13.3 (x-cash). While this is not cheap considering current markets, I think that this is a good company that is well positioned to take advantage of infrastructure spending.

NOTE: This post is not intended as a recommendation but it is aimed at generating a discussion about the company. I may or may not own shares in the company mentioned. Do your own due diligence. Do not solely focus on the potential profit but make sure you understand the risk of any investment.