OSI Geospatial(TSX: T.OSI, Stock Forum)
Heading into 2010 I started following OSI as a very promising growth story in the tech and defence sector. Recently a very serious threat surfaced in a key shipping lane that (if it occurs) will have far reaching implications for Asia and global trade. OSI’s speciality is the marine industry and any such attack would generate a lot of interest in a company like OSI.
The issue we face however, is that the timing is so unpredictable. If it was to occur, the stock would likely move so rapidly, and a lot of big gains could be missed. So a potential strategy is to bottom fish while the valuation is very low, but knowing a terrorist attack within the industry could provide a dramatic turn in the fortunes of the company.
The driver with OSI would be its focus tracking small vessels either controlled by the ship itself, or the threats of approaching and unidentified vessels - similar to what it did at the Olympics. Over 400 large ships around the world use OSI digital charts and mapping so incorporating the company’s small vessel technology would not be difficult.
The recent threat surfaced in the Strait of Malacca, which is a critical shipping lane between Europe and Asia. An attack on an oil tanker or liquid natural gas transport would have an economic impact, but an attack on a fertilizer transport could turn into a giant bomb.
The Strait of Malacca between peninsular Malaysia and Sumatra is among the world's busiest shipping lanes, used by more than 70,000 ships in 2007. Up to 80 percent of China's oil imports and 30 percent of its iron ore imports, and 90 percent of Japan's crude oil imports pass through the Strait.
The Singapore Shipping Association noted: "In past cases of successful terrorist attacks on tankers, smaller vessels such as dinghies and speedboats were used. Analysis of past incidents of sea robberies and piracy in the Malacca Strait has also revealed small fishing vessels such as sampans were used to board victim ships."
Financials
Recently OSI came under selling pressure when it reported weak Q4 financial results due to delays in a large UK contract. In this market the bar is set high, and if you miss it, the market will punish you.
When the smoke settles in Q1/10, at a potential valuation of 20 cents, OSI would trade near its net cash value of about $5 million. The weak quarter doesn't change the fact this company's extensive business and technology are currently deemed worthless by the market. At some point we need to see top line revenue growth and profitability, but for now I can easily wait a couple quarters to see what new contracts and markets the company is able to secure.
Upside can occur on various fronts but we'll obviously need to be patient. The problem is that old shareholders have lost patience and are punishing the company for its failure to grow top line revenue. We are new to the story, and have a different perspective, but will still want to see noticeable improvement in top line revenue growth.
Financials released May 1st caused an initial knee-jerk reaction but were well explained in the company’s conference call. Unfortunately a UK contract with the Royal Navy (in typical government fashion) has dragged out and affected the marine division to the tune of about $3 million for the quarter. Overall the annual revenue of $23 million is down 14% from 2008 but nothing too earth shattering - considering what happened to the economy and credit markets during this same period.
This would have been an issue had the stock been commanding a much higher valuation but considering it trades below 20 cents, the value is definitely there. This year in particular we are watching for decent sized contracts and/or new markets. The quarterly financials are important, but when we're dealing with such low market cap companies, these are far from being valued on earnings per share (eps). If that was the case, we would not be dealing with a little penny stock.
Instead, we assume 2009 was a transition year for OSI (coming off the economic beating) and 2010 should be the year it begins to turn around and show top line revenue growth - and I assume profitability towards year end. The order backlog remains strong at $43 million and about $9 million of that will be recognized in 2010.
Conference call summary
- weak Q4 was a result of delays in project execution from contracts signed in previous years, and the signing of new contracts and contract options - the UK Royal Navy in particular. Process has been underway to resolve the issue. CEO was unhappy with overall 2009 financial performance but (obviously) sounded optimistic about 2010 and 2011.
- firm order backlog of $43 million with approximately $9 million of this to be recognized in 2010 and $34 million in 2011 and beyond. Backlog the end of 2008 was $57 million. Large government contracts can have lengthy sales cycles so backlogs can vary considerably.
- sale of small division in February will add $5 million to balance sheet (after taxes). This resulted in closure of San Diego office.
- Total employees in the range of 100 and there remains an ongoing effort to reduce costs where possible. Q4 saw 25 positions eliminated as OSI foresees a slowdown in its land based mapping market, which is highly competitive but only 16% of total revenue.
- focus will be military command and control, homeland security, and maritime defence.
- The past three years has seen significant investment in technology R&D. This is what allowed it to sell the division (above) to Harris. Numerous other technologies have been developed that may lead to sale, partnership or commercialization over the next couple years.
- Top line revenue growth over the next year (and beyond) will come from technology innovations of the past few years that are now being fully marketed and generating significant interest. This is not only coming from NATO countries, but the Middle East and Asia.
- New marine products and technology include advance tactics and monitoring of small boats not only in port, but almost every Navy ship has several small vessels associated with it and this is new technology that hasn't been available before. Several navies are undergoing field tests and the U.S. trial will be used in the Persian Gulf this year. The company has technology and software in more than 400 ships worldwide and each is a candidate for this new small vessel command and control.
- shore based tactical control and security was employed very successfully at the Olympics and is generating substantial interest for OSI.
- it expects the most growth from patrol vessels around the world. This incorporates technology associated with weapons, navigation, and combat.
- the company is also seeing considerable interest in its new combat/medic and emergency medicine training solutions. 15% of battlefield deaths are preventable and this is funding that is seeing priority from the U.S. government. I could not find details on this discussion but it seems to center around the divisions focused on cognitive engineering and simulation-based training.
33 Years in business and the market values the business itself at zero (?!)
I have reviewed OSI's financials going back three years to try and identify where the issue may exist with respect to valuation. Part of the problem lies in the fact the company has remained "too" stable - top line revenue growth has remained flat (key financial data summarized mid report).
Complicating matters is that it hasn’t required financing for a long time (brokerages then have little interest in following them) and it doesn’t have an active IR program, preferring instead to wait until it can show growth in bottom line earnings (EPS).
Fortunately if you recognize the underlying value in this price range (and have the patience), the positives far outweigh the negatives. The key with making significant gains on these small companies is knowing when to ignore the perception created by the stock price (because the market is typically wrong with valuation on them), and accumulating positions as low as possible (bottom fishing) before we see growth in top line revenue or earnings, and/or before they may possibly be bought out.
OSI’s market capitalization (share price x shares outstanding) has varied considerably the past few years, even though financials have remained (essentially) the same. Valuation was hit hard in late 2008 and early 2009 when markets collapsed but otherwise were in the following ranges: 2006 $20 to $30 million, 2007 $15 to $30 million, 2008 $5 to $16 million, and 2009 $4 to $8 million.
Order backlog has remained stable (currently $45 million) with sales relatively flat in the range of $20 to $25 million. The major difference heading into spring 2010 is the recent sale of a noncore division for $7 million that once cash and receivables offset small debt, the market values the business itself at Zero - because near 20 cents the stock trades for its cash liquidation value. This is the key point in valuation that we are (now) most interested in.
With this recent division sale (soldier systems intellectual property), the company is turning its focus to the marine market where it has specialized for decades (detailed below). It believes this will generate the growth it has been missing as technologies advance and we see an expanded use of global positioning (gps) or geospatial systems. It is important to remember that this is the area of expertise for OSI over the past decade, but it was years ahead of the curve (implementation by industry in large scale).
A perfect example is our own usage of GPS in vehicles. A couple years ago it was a novel idea. Now it is almost becoming necessity. In addition, we are now seeing personal GPS expanded to mobile phones because of increasing popularity. The added benefit for OSI is that the majority of its business lies with government and military - although the sales cycles are longer, the contracts are large.
Here is a summary of what has happened over the past two years. The first number represents 2008 and [ ] 2007 - all numbers in millions and for the year ending November 30th. The 2009 numbers were very similar but top line revenue growth was down 14% due to Q4 contract delays (mentioned above).
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Accounts Receivable $9 [$13], Goodwill $8 [$8], Equipment & Vehicles (cost $6m) $1 [$1], Total Assets $22 [$26], Liabilities $6 [$7]
Revenue $25 [$25], Gross Profit $9.2 [$9.7], Administration $5.4 [$6.1], Sales & Marketing $3.9 [$3.8], Engineering & Other $1.1 [$1.3], Gross Profit Percentage 36% [39%], Shares Outstanding 46 [41]
Data for the nine months ending August 2009
Cash & Receivables $7.5 million (debt $5 million)
Q3 Revenue $6 million and YTD (9mths) $18 million (2008 9mth was also $18 million)
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The sale of a non-core division in early February will have minimal impact on current revenues but adds $7 million to the balance sheet. Based upon the end of last quarter, this would give the company about $14.5 million in cash & receivables with only $5 million debt. At 20 cents, the market cap is only $9 million - meaning the company trades at the value of its net cash and receivables ($14.5 minus $5 million debt).
This means the business itself carries a value of ZERO but represents the following:
- 33 year old company (17yrs on TSX) generating $20 million + in annual revenue
- client base that includes major ship operators, government agencies, and Navy & Coast Guard fleets.
- technology development partners include such names as CAE Inc., BAE Systems, General Dynamics, Lockheed Martin, Kelvin Hughes, Nautronix, Northrop Grumman, & Raytheon.
- a global leader in military and commercial Marine Navigation, Small Boat/High speed Command and Control, Warship & Submarine Situational Awareness & Combat Control, and Maritime Security providing:
1) enhanced real-time situational awareness & interoperability 2) command and control technologies and navigation systems providing essential tactical, strategic, and operational information 3) technology that helps aid decision-making, improves efficiency, and provides real-time access to all available information
For every 10-cent increase in share price, the overall valuation goes up only $5 million - a 50% increase from current share price levels while only marginally increasing the overall value of this company.
Its backlog consists of firm, fixed, or signed orders issued and executable subsequent to the balance sheet date. Firm backlog as at November 30, 2008 was $46 million compared to $49 million at November 30, 2007. Of the $46 million firm backlog, $11 million is expected to be executed in fiscal 2009 and $35 million is expected to be executed in fiscal year 2010 and beyond.
The Company also has un-deducted scientific research and experimental development expenses for Canadian income tax purposes of approximately $10 million, which are available for carry forward to reduce future years' income for tax purposes.
Review of the OSI business model
OSI delivers systems and services that include Warship Electronic Chart Display and Information System (ECPINS®-W), Warship Automated Identification Systems (W-AIS), Asset Control and Tracking systems (ACT) and Small Unit Situational Awareness systems (SUSA). The Company's International and U.S. Systems business units develop and produce geographic information display systems and software for the marine navigation, and command and control markets, and situational awareness products for land-based and aeronautical command and control markets. The Company's Mapping business unit provides digital land map and electronic nautical chart production services, and produces and distributes digital land map data and electronic nautical chart data.
Notable news this past year
- June begins working with Turkish Navy (supply navigation systems for 8 new cruisers)
- August begin new work with Royal Netherlands Navy
- September signs contract with Canadian Department of National Defence to develop system for training and detecting roadside bombs (ied's)
- November signs undisclosed submarine contract - their 11th naval customer and 6th submarine customer (all members of NATO).
- December signs submarine contracts in Brazil
- Feb 2010 sells non core division (little impact on current revenue) for $7 million. Buyer is large defence contractor, Harris Corp.
In addition, for some odd reason, Marport.com had this news on their website in September but it was never released by OSI. The two companies signed a teaming agreement to incorporate their technologies (Marport is a leader in underwater defence using sonar). The sonar system identifies threats and the OSI system manages all the information. It will open up new opportunities associated with: harbour surveillance, coastal perimeter surveillance - naval bases, power plants, etc., strategic waterway access monitoring, and protection of high value assets - surface ships, offshore drill rigs, etc.
OSI's Electronic Chart Display and Information System (ECPINS®-W) is installed on more than 400 ships around the world and can be easily equipped to incorporate this new sonar technology. This is only one area of new growth for the company. As I have previously mentioned, if we ever see a terrorist attack on the U.S. that is significant and marine (or port) based, this stock would attract huge interest. The November 2008 terrorist attack in Mumbai (on the luxury hotels) that killed over 100 people, is a perfect example. The terrorists came onshore through the sea port on high speed zodiacs.
Eventually we may see critical ports around the world monitored like air traffic control. OSI has the only technology available for doing this with large or small water vessels. This is not something that we assign value to but it reflects future growth opportunities. For now the existing business is more than enough to substantiate a much higher share price.
Disclosure: Danny Deadlock owns 50,000 shares of OSI Geospatial acquired in Q4/09 and Q1/10.
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Danny Deadlock has specialized in microcap and smallcap companies for over 25 years and is a registered member of the Stockhouse community since 1997. You can find his website at www.MicroCap.com - a service which has specialized in TSX and TSX.V penny stocks since 1998. You can also email Danny at microcap@telus.net