Cheap Company to Consider: Communications Systems (JCS)

Communications Systems Inc, together with its subsidiaries, manufactures and sells modular connecting & wiring devices, digital subscriber line filters, structured wiring systems, and media and rate conversion products in North America and EMEA region. The Company operates through four segments: Suttle, Transition Networks, JDL Technologies (JDL) and Net2Edge.

Communications Systems is headquartered in Minnetonka, Minnesota. The company was organized in 1969. The company operates directly and through its subsidiaries in the U.S. and in the U.K. The Company operates through four segments:

Suttle (which manufactures connectivity infrastructure products for broadband and voice communications) 42% of total revenue 2016,

Transition Networks (which designs and markets media conversion products, Ethernet switches, and other connectivity and data transmission products) 41% of total revenue,

JDL Technologies (JDL) (which is an IT managed services provider and value-added reseller) 15% of total revenue and

Net2Edge (U.K. subsidiary which develops, manufactures and sells products to connect legacy networks to high-speed services) 2% of total revenue.

 

Investing case

Communications Systems’ valuation is very low. Stock price is 15% lower than the company’s net current asset value. The company also has a substantial amount of fixed assets in its balance sheet. Because of this P/B ratio is only 0.63. If some progress is made in the profitability of the business, it seems reasonable that the stock should trade over its NCAV closer to its tangible book value (where it has used to trade traditionally). This gives room for the stock price to rise over 55% to its intrinsic value.

Market consensus has doomed Communications Systems as a perennial looser because of declining revenue and missing profitability over the last couple of years. Also lack of analyst coverage doesn’t boost crowd’s confidence in the stock. The recent losses can be mainly attributed to Suttle. The company has carried out major restructuring measurements in 2017 (the business unit has recorded $2,326,000 in restructuring expense during 2017). Management is working to turn the Suttle business unit around. It looks like the worst part is over. Even though the company is not currently profitable, the company has the financial resources to see through this operational turnaround.

The low price to tangible book multiple in combination with a strong balance sheet provide good down-side protection. Although the return to profitability would take longer than the company expect, it looks like the bottom is reached. S,G&A expenses have been reduced finally and Communications Systems is still steady dividend payer, which supports confidence in the future.

Should Communications Systems be successful in increasing top line after restructuring or getting new contracts, they could easily return to produce positive cash flow, which would create significant upside in the stock. Famous value investor Mario Gabelli’s GAMCO owns big stake (12.5%) of the company and might be trying to pressure the board. Because nearly 5% of GAMCO position belongs to Teton Westwood Mighty mites, it is likely that famous micro-cap investor Paul D. Sonkin has also discovered the undervaluation of the company. Then again, like in many other deep value cases plain low valuation work as a catalyst as well.

 

Valuation

Communications Systems (JCS)

Market Cap: $31.57 M

Price: $3.52 (Net Cash 0.85, Net-Net Working Capital 2.85, Net Current Asset 4.25)

Tangible Book Value: $5.70

Price/NCAV: 84%

P/B: 0.60

F-Score: 5

Z-Score: 3.64

Debt to Equity: 0.0

 

The company’s background

The original founder and current chairman of the board Curtis Sampson is also the largest shareholder of the company with a holding of 13.0%. He founded the company in 1969 and has been a director since its inception, serving as CEO from 1969 to 2007. Randall Sampson, the son of Curtis Sampson, is also represented on the board and has a shareholding of 1.5%. Other directors or management do not own significant amount of company’s shares.

Communications Systems has seen declining revenue over the last couple of years, the difficulties seem to be related to company-specific issues rather than to macro trends. Even though JCS is in an industry with low barriers to entry, spurring high competition tech analysts are forecasting for the entire hardware tech industry a massive growth of 30% over the next couple of years. The recent losses can be mainly attributed to the business unit Suttle. It has been the biggest business segment, but recently marginally profitable Transition Networks business unit has grown past (or in practice decreased less). It is not a big news, but positive anyway. JDL Technologies has been the most profitable business unit during the last two years. This subsidiary has long contracts and will be strong in the near future. Unfortunately, the impact on the whole of the company is only minor.

Valuing assets of Communications Systems we have to consider following company specific factors. Cash and cash equivalents are what they are, they have collected receivables quite a well (less allowance for doubtful accounts under 1%), but write off of a lot of excess and obsolete inventory primarily related to Suttle’s legacy products. In addition, big inventory write offs and adjustments by Transition Networks. It means that regarding inventories we have to make an adjustment. On the other hand, Communications Systems owns most of the real estate used in its operations. An accurate estimate of the value of real estate is challenging (Minnesota facilities maybe easier than Hector), but conservative gauge would be somewhere in the $11-13 million range. This will easy compensate adjustment of inventories and adds the margin of safety of an investment in the company’s stock.

The company also has a poison pill, thus it is not the easiest target for activists. It is also unlikely that current owners and management would be willing to sell the company. Missing these catalysts, the development of the current business is the key. JCS has delivered lower growth relative to its tech peers in the near term and the market may be pessimistic on the stock, leading to a potential undervaluation. And even the smallest positive business news can cause a sharp rise in stock price.

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