Short-term problems create long-term opportunities for the far-sighted investor.
Any company valued at the price of its assets with a big chunk of cash and good long-term prospects to boot deserves a second look.
Such is the case for AIM-listed computer-aided design software specialist Delcam (LSE: DLC). Delcam is now the biggest developer of this kind of software in the UK, and has subsidiaries in North America, Europe and Asia. It employs the largest number of people using computer-aided manufacture in the world with 56 staff in India and 48 in China.
The company is also unique in being the only CADCAM software supplier with its own tool-room, which means it can make complex 3D products for its clients when needed.
Big R&D spend
At the current mid price of 240p, Delcam is valued at £18.5m, but has over £6m in cash and spends a relatively whopping £9m a year on research and development. Big R&D expenditure in relation to overall valuation is a double-edged sword. It's tempting for the value hunter as it means the underlying business is highly profitable and you know it could be trimmed down if need be. The bottom line would then look a lot better for a while. But for how long? Any competitive edge would be soon lost and Delcam's management has a long track record in managing its affairs. In fact, the management team has been in place since the flotation in 1997.
Just under 30% of the company's revenue is highly predictable, recurring income from maintenance revenues from software licence renewals. During 2008, Delcam turned in a respectable profit before tax of £2.3m and basic earnings per share of 21.2p. This level of performance, though, won't be repeated this year. May's trading statement revealed that pre-tax profits for 2009 will be in the region of £1.2m, placing the shares on a current price-to-earnings ratio of around 18 -- not exactly value territory. The announcement sent the share price under £2.
The long game
But we'd already heard with the finals that trading conditions had deteriorated significantly. Since then, it seems, Delcam's performance declined further. So it's all bad news and best to stay away? Maybe. Yet it's also wisest in the long run for investors to buy well-managed companies with quality assets on temporary weakness in share price due to relatively short term economic problems.
And Delcam is playing the longer game, which may appeal to investors whose time horizons extend beyond a week on Friday. The directors believe that recovery in manufacturing will happen next year and that the next two years, while difficult, will present an opportunity for the company to increase its market share.
Two years ago, precision engineering group Renishaw (LSE: RSW) saw fit to take a 20% stake in Delcam. It's easy to see why. Besides the complementary nature of their businesses, both companies are the quiet, steady progress types. What's even more interesting is that Renishaw paid almost twice the current price.
Delcam still has net cash of £6.1m equivalent to almost 80p per share -- roughly a third of the current £18.5m market cap, and an overall net asset value of over £16m. So it's not going away any time soon. Over recent years, it's been a case of two steps forward, one step back, as the company makes generally steady progress in building turnover and profitability.
The shares have perked up quite a bit recently -- from their nadir of 180p in March so there could easily be a little profit-taking. But Delcam is definitely worth keeping an eye on as a long term buy and hold investment.
Anyone looking to invest in the company today needs to decide whether the current valuation is a short term price depression associated with wider economic factors or a long term problem for an averagely run company in troubled times. I think it's the former.
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