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OmegaFlex, Inc. Message Board

  • wavetrader321 wavetrader321 Oct 5, 2006 10:55 PM Flag

    Alternative Valuation Ananlysis

    I thought I'd present an alternative position relating to OFLX's valuation in an attempt to make the argument that contrary to the opinion of some who post on this board OFLX is not expensive at current levels.
    First, revenues have grown at a 21% annualized rate from 2001-2005.
    Earnings over the same period have grown at a 27% annualized rate (indicating management has been abe to keep costs under control while rapidly growing the business).
    Return on net assets employed has been near 60% over the time frame mentioned above (which would seem to indicate to this observer that OFLX is a business with a sustainable economic moat - possibly due to several of the patents they hold and their proprietary method of fabricating flexible tubing).
    It is true that OFLX has an earnings yield of approx 4.5% but this is not a static number. As earnings grow, the earnings yield on one's initial purchase price rises. Considering OFLX's rapid rate of growth in earnings I think one is only kidding themself if they believe this type of growth can be bought at a current yield closer to 8-10% (don't forget - when Warren Buffet bought Coca-Cola stock in 1994 it had a current earnings yield of 4.5%).
    There are also some intangible factors that I believe are worth noting. For starters, management owns close to 70% of the common shares outstanding. If your desire is to be on the same team as management, there is hardly a better situation than this. Expanding upon this theme; the fact that execs are net buyers of the common is notable. While insider buying has been relatively modest, I consider the fact that execs are not regular sellers of their holdings quite encouraging. I find it extremely like that this company will be taken private in the not too distant future via an insider-lead LBO (there's a reason they're not leveraging this pristine balance sheet and holding on to every single share). Now that a full year has passed since the spin-off, the negative tax consequences of aquiring the company are gone making it even more likely this co. will be aquired by either management or another co.
    The bulish argument for OFLX could be extended with a description of positive industry fundamentals, an innovative product that is quickly becoming industry standard, a diverse customer base, high returns on shareholder equity etc... but I have to go to bed and I believe the argument put forth in the preceeding paragraphs is justification enough to consider OFLX a compelling buy at current levels. Please excuse any spelling errors in this communique as I do not have a spell checker available on this computer.

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    • Few growth companies, somewhat early in their growth phase, are generating both earnings AND cash flow on the relative scale of OFLX. This business is doing so because its return on incremental invested capital is so high. (similar to Warren Buffet's See's Candy during its earlier years) My estimate of IV today is $25; and this is not a static number. It probably will grow nicely over time, as the business continues to expand both geographically, and as its products displace alternate systems. The growth will likely be somewhat lumpy, both internationally and with domestic construction industries (residential, commercial, institutional, and industrial); still, OFLX should expand at a favourable rate for those with a multiyear time horizon. OFLX has the best management in its industry, and is increasing the space between it and the competition. True, the name is not "dirt cheap"; but why even consider paying capital gain taxes on this winner, unless you have some exceedingly special alternative investment?

      I've offerred my estimate of IV; what is yours?

    • If you go over the extensive discussion on this post under �too expensive� you will notice that I have made very clear statements that this is a good well managed business � so there is no disagreement on that and no need to further state the obvious. Where we disagree in a material way is the current valuation. I strongly believe that it is a mistake to assume that a good company translates into a good investment. I stay away from using the word �risk� without a qualifier in front of it. So to be specific, investment risk for me consists of two components: 1) the quality of the cash flow stream � and this includes quality of the business, management, industry dynamics, etc.; and 2) the discount to the intrinsic value at which I can buy a small claim on the cash flow stream � i.e. shares in the business. Both need to be present for the investment to produce satisfactory returns. In my judgment, while both criteria �checked� at OFLX one year ago, today the second one is way out of hand � i.e. the current market price is materially higher than my assessment of the company�s intrinsic value.

      To summarize my views, I strongly believe in the following:

      1. Investment Risk is measured by the discount to intrinsic value � the bigger the discount, the lower the investment risk.

      2. A good business does not translate into a good investment � price is crucial.

      3. Not being able to find investments at a satisfactory discount to intrinsic value CANNOT justify investing in situations where the expected return is not satisfactory � i.e. agreeing to take whatever the market offers at the time. I see many other opportunities where the investment risk is well compensated by a significant discount to the intrinsic value, hence my decision to redirect my capital away from OFLX. BTW, many value investors (including WB) have done well by patiently holding cash and waiting for an investment opportunity to present itself, than buying good companies at whatever valuation the market offers them at the time, just because they couldn�t find anything better at that time. Cash can be a strategic asset.

      For all of the above, I believe that OFLX is a good business with decent prospects, but is not a good investment offering acceptable returns given the price at which it currently trades.

    • wavetrader321:

      You make some valid and interesting points. However, I don't understand why you consider it to be a likely LBO. Don't the Reed's own most of the stock? Why would they spin it out of Mestek only to buy it back again?

      • 1 Reply to pmlljl
      • I am glad there's a continuing discussion on the merits of OFLX. At the risk of being repetitive I'd like to make the following points:

        1. Historical performance: While OFLX had a very good historical performance, investing is done prospectively, not retrospectively, and I don't believe the future is as bright for OFLX as the past due to cyclical, seasonal and market maturity issues all elaborated earlier on this post.

        2. Coke vs. OFLX: Comparing OFLX to Coke is a stretch in my mind, as the risk factors - business, operational, financial, market, etc. are way more pronounced in a micro-cap company than in a large cap company.

        3. Capital Gains: I'd rather pay tax on the gain than lose the gain, it�s that simple.

        4. LBO/Acquisition: for many reasons, while possible (anything is possible) an acquisition is not likely for many reasons � low economic returns due to the high current price, lack of cost synergies, top management�s golden parachutes, etc. I also don't believe in buying a stock the upside in which will come from the prayful belief that someone will come and buy the company - that can be the icing on the cake but not the underlying value premise of the investment thesis.

        5. A special word on insider buying at OFLX: There was a recent Motley Fool's article �Who's Buying Now?� by Tim Beyers - , and I feel that a word of clarification is required.

        I am not going to comment on the �profound� analysis in the Motley Fool article which points to the latest insider purchases and says that the 52-week stock appreciation for OFLX as of 10-3-06 was 18%, ignoring the latest slide in price of over 25%. I am also not going to comment on the fact that while mentioning $8.6 million in cash on OFLX�s balance sheet, there�s no mention of the $11 million payment the company needs to make following the recent legal settlement � this clearly was not in the Motley Fool analytical tool kit.

        But the comments on insider buying are more interesting, so the question is �who�s [really] buying now� and why? To put in perspective again the recent purchase of 1,000 shares by OFLX�s CEO � his only open market share purchases since the spin-off in 2005 - pls note that he already owned 1,016,213 shares or 10% of the company through an old arrangement with Mestek�s owners, not though open-market share purchases! This means that he chose to increase his holdings by 1/10 of 1% - yes by 0.1%. How much richer does that make him? Also his acquisition of 1,000 shares was at the grand total cost of $19,620, or 2% of his cash compensation in 2005, which was over $900,000! The size of the share purchases of some of the other managers and board members are even more absurd � ranging from 100 to 500 shares. So while from an economic perspective it�s hard to find the immediate rationale for the recent (to quote the article) �muscular buying at Omega Flex�, there�s a very clear perceptual value (but only for those who don�t do their homework) to be derived, as exemplified by the Motley Fool article and their �analysis� and statements for �muscular buying� at OFLX..

        In summary, I believe that investing is all about personal judgement calls on risk and return. While this equasion looked appealing to me a year ago when OFLX�s prospects were much better than today and the stock price was � of its current levels, the opposite is true today � prospects are worse and stock price is 2x higher. Thanks for the inputs � I welcome any further valuation-based discussion on the stock.

    • Good thoughts. I am sure that I will once again bring the wrath of Value thoughts, but I wanted to comment on this post. I will continue to say as I have in previous posts that OFLX is a prime candidate for an acquisition. The value certainly took a hit and rightly so because of the judgement. I think that this company going private by management is highly unlikely since it was spun out to gain access to public equity markets to provide a liquidity event to a talented but aging group of insiders. Your comments about the proprietary technique for making this product is exactly what makes it an attractive acquisition target. Value's comments on lack of synergies lacks an understanding of the industry. This technology has existed for 30 plus years and competitors have been unable to replicate. It provides for an ability to produce the product with significantly less factory space and required labor. Much larger competitors with more expanded distribution networks and more capital capacity will salivate over this technology. The key for management is picking the right exit point. I have said before I beleive that the low end of this range is $32 or so. I thnk value significantly underestimates the cost savings a larger company could yeild by stripping out senior management salaries but more importantly bonus payouts which have been quite rich over the last few years. While I don't have a good feel for a perspective time frame for such an acquisition I do not believe it is as far out as Value has mentioned in previous posts. My money is going to wait and see. Of course I did not ride this gem up from $10 - $24 like Value claims to have done. Mind you that ride took place in more or less than a 12 month period. Not a bad return on investment if you ask me. Now I hardly beleive that will be repicated in the next couple of years but I do beleive that we are in for $10 - $12 per share in the next 18 months or.

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