Risk/reward We have a high concentration customer risk that needs to be weighed.
Customer #1= 65%
Customer #2= 20%
All the other customers, all less than 10%, make up the remaining 15 % of sales more or less. If this company were to lose their top 2 customers it would be catastrophic to their share price and may trade for no more than their book value. On the other hand, if these 2 customers remain as customers for the next decade or 2, then there is further upside potential.
What happens if customer 1 is only a customer for 1 more year. At 65% of current sales, that would be a big drop and huge loss for the company. Of course, the same thing could happen to customer 2 or a combination of these. Its always a good idea to understand the best and worst case scenario of any investment. One needs to assign a probability and market value to a worst case scenario if they lost their top 2 customers. I would guess that the company may trade at no more than book value. With a market cap of just over 100 million, Pro-dex has a book value of about 20 million. In a best case scenario, the current customers remain as customers and the company is worth $150 million. One may argue that if customer 1 and 2 which represent 85 % of sales were to cease as being future customers then the market cap would be worth (100%- 85%) x $150 million or about $22.5 million. If we have a 50/50 split on best to worst case outcomes, then there is a $50 million increase on the upside and a $77.5 million on the downside. The risks in this case outweighs the reward so it would be wise to stay on the sidelines or eliminate as a potential investment. However, if the share price were to drop to $65 million then we would have a favourable outcome. The reward in this case would be + $85 million and the risks would be -$ 42.5 million
Since I hold a concentrated portfolio, this investment is of no interest to me. It may, however, be of interest to someone with a diverse portfolio and if the share price were to drop an additional 25-35%