Sunday, October 09, 2005

Tangible Book Value as Downside Cushion

Bonso Electronics, Inc. is a really great classic value stock that we don't ever expect to find on the market anymore, but nevertheless, it is there. I've looked everywhere for a possible reason why the stock can be so cheap, and here are some reasons I've found:

- Company operates in China, where the political/business environment is uncertain
- Company is losing sales in one of its seasonal segments
- Company relies too much on 7-8 large customers for its sales

True, these are very good reasons why a company would be trading at a discount. Currently the ratio of MC/FCFE on this company is around 6x... pretty steep, even for a company with that kind of risk.

Now, the China risk is understandable. This company incurrs around a 15% effective tax rate because of a special business status it holds in the ShenZhen area, should that change at anytime, they would be forced to pay higher taxes that would lower their profits.

But the fact that the sales on a seasonal segment is flailing should be no cause for concern--this is their telecommunications product segment by the way. The Scales segment is growing and is projected to more than make up for the losses there (Scales segment have better margins, and better scale 'no pun intended' har har har)

The 7-8 large customers is not a problem either because the company is actively seeking out new partnerships and also is integrating distribution channels to offset potential loss.

NOW!

I like this stock not only because of the attractive discount, but also because of its limited downside. Even if all the worse case scenarios happen, the company still boasts a tangible book value of around 30m, which would more than cushion the downside. We have very little risk in that area.

What happens if the company starts losing money, you say? Well, due to the nature of the company's operations (a manufacturing facility in China), it is highly doubtful that the costs of running this company would be fixed to the extent that a reduction in sales could reduce its margins enough to go into the negative. As cruel as it sounds... Chinese labor is very expendable.

Anyway, I'm beginning to put a small position in the company for the Initiative...

3 comments:

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