In watching market reaction to Microvision news releases it is increasingly obvious that the stock market is unable to properly value Microvision equities. Much of this problem is likely to accrue from the following factors: (1) Most of Microvision's marketing success to date had fallen within the Defense sector. Due to deep and continuing defense spending cuts the defense sector has been in a period of consolidation since 1990. (2) Microvision's competitors in providing micro displays to the Defense Department are either divisions within larger entities such as Honeywell and Texas Instruments or very small publicly held niche firms such as Universal Display or privately held firms such as Kaiser Electro Optic. Where as Honeywell and TI have adequate analytic coverage, their display activities are a small portion of corporate revenues and are difficult for analysts to value as pure plays. (3) Microvision press releases rarely mention contract revenues while quarterly reports leave little doubt as to the firm's negative cash flows and declining liquidity.
Given items (1) and (2) there is little analytic coverage of the micro display sector and little expectation that firms marketing to the defense sector will exhibit rapid earnings growth. This absence of analysis is further exacerbated by the dearth of direct information on Microvision's prospects for future profitability. Indeed, investors are left to their own devices to evaluate VRD technology, competing technology, possible cash flows accruing from military contracts heretofore announced and contracts alluded to in the Commerce Business Daily. This situation crystallized on 9 March when release of VERY positive news of a new Army contract was greeted with a 7/16th of a point rise in Microvision's stock price on moderate volume. This market reaction suggests that some current investors seized the news release as an opportunity to reduce their positions while few new investors found substantial market value in the 8 March Army contract news.
Whereas no firm should engage in hyping its stock, neither should it allow a situation to persist in which it is virtually impossible to fairly value its equities. To allow such a condition to persist while returning to the markets for additional capital does damage to investor confidence. In January Microvision found need to raise additional capital through a private placement with Ms. Elardi. While I welcome Ms. Elardi's presence on the Board, her purchase of convertible preferred stock resulted in dilution of investor value in Microvision. Though I clearly prefer dilution to illiquidity, the issue posed in these terms is a false dichotomy. Microvision's outstanding warrants represent an untapped windfall that will net the firm $25mil+ when exercised. However, given the markets' continued indifference to Microvision we may not see the warrants exercise until after development costs make further private placements and dilution necessary.
For its part, Microvision can mitigate this situation by adopting a more effective communications strategy. We now have a Director of Investor Relations. He of course must have a message to convey. Recently, Microvision had no public comment following the 13G filling by Mellon Corp. announcing the sale of 320,000 shares of MVIS by Dreyfus. Of course this filing was a regulatory footnote to selling Dreyfus engaged in during the summer of 1998. Investors who were not privy to such information, and who could not clarify the Dreyfus situation through reference to market analysts, were left to draw their own conclusions. Investors were similarly left to discern the meaning of insider selling during February. Whereas Microvision's relations with the military may warrant reserve in communicating the nature of military projects to investors, Microvision remains a publicly held entity that must raise capital in markets that move minute-by-minute on firm specific news and macroeconomic shocks. By way of example Microvision could provide some indication as to the value of recent contract awards as well as revenue and cost sharing arrangements which are certainly part of the Boeing collaboration. Neither the recent Navy contract news nor Army contract news incorporated any hint as to the revenue streams likely to accrue to the firm. Consequently, investors are left to their own speculation. If outside analysis were available, Microvision's financial situation would be far less opaque. However, such analysis is not available and excellent news passes the market by like flatulence in the wind. Thus, as the situation stands, Microvision, and its investors, suffer from a classic market failure. Economic models hold that markets efficiently value assets when information is well distributed. In the case of Microvision we have substantial information asymmetries which preclude a fair market valuation of the firm. Therefore, until we see cash flows that Wall Street cannot ignore the stock will remain substantially undervalued. As an investor I find this situation objectionable from the perspective that the firm may be forced to make further use of private placements and incur further dilution rather than liberating the value presented in its warrants.
Given this situation I have prepared the following analysis of Microvision's penetration of the market I know best, the Army.
First we have Microvision's work for Army's aviation program. On the basis of the most recent contract announcement we know that Microvision is now working with Boeing as its subcontractor to deliver an integrated flight management /situational awareness suite to the Army for further evaluation and potential integration into Army aircraft. One may first ask why is Boeing the subcontractor? My estimation is that Microvision has the technology the Army wants.
Since the 1980s the Department of Defense has contributed tens of millions of dollars to develop an indigenous flat panel display market due to the critical importance of these displays to the military. To date, this effort has garnered only modest returns. Universal Display, Kaiser and others have failed to deliver the brightness, resolution, power efficiency and human interface required by the military. Testimony to the persistence of these failures can be found in delay of the Land Warrior program this past fall.
Army modernization plans center upon the rapid and effective dissemination of information across the battlefield and between leaders (the Force XXI effort). Thus the Land Warrior, Air Warrior and Mounted Warrior programs are first and foremost programs to apply information technology to light infantry, aviation and mounted forces. As evidence of the urgency of these projects the Army plans to field information technology appliques known as the Force XXI Brigade and Below Battle Command (FBCB2) in the 4th Mech Division by 1 Oct 1999. The 1st Cavalry Division will be equipped the following year with further dissemination of the technology so as to field a fully digitized Corps by 2004. Army procurement to support this effort will include purchases of some 45,000 Land Warrior sets at a unit cost of $70,000 each. It will also involve procurement of 2000 vehicular FBCB2 sets per division at a price yet to be announced. At the core of both the Land Warrior and FBCB2 efforts one finds computers and displays. In the case of Land Warrior the display was to be a helmet mounted micro-display based on flat panel technology. In the case of FBCB2 Army procurement documents call for “Display Unit is a 256 Color LCD with minimum 800 X 600 pixel resolution. The display has an integral touchscreen capability, is fully sunlight readable in bright sunshine, brightness level is gradually adjustable from full brightness to total blackout conditions for night time operations”. In my estimation, VRD will better satisfy Army requirements for brightness, field of view, resolution, energy efficiency and human factors than the competing systems mentioned above. One can also draw upon Army procurement actions and leadership comments to gain a sense of Army interest in VRD. In his 8 March 1999 comments to Defense News LTG Paul Kern, the Army's chief procurement officer, offered insight into the Army's interest in VRD..
“With an eye toward future heads-up technology, the Army is developing a retinal imaging helmet display for its RAH-66 Comanche helicopters. "It's a very exciting technology we're looking at," Kern says'. The Army is working with the Air Force and the Navy on the new system. The retinal display will use a miniaturized high resolution projector to generate images on the
retina of a pilot's eye. More bulky monocle helmet displays are used
on the AH-64 Apache ... “
Without comment by MVIS or outside analysis investors are left to sort out the meaning of LTG Kern's comments. Based upon my reading of the situation General Kern's use of “retinal display” refers to the work Microvision has performed for the Army.
Importantly, LTG Kern's last assignment was as the commander of the 4th Mech Division. That unit is the Army's experimental test-bed for battlefield digitization that is at the core of the Air, Land and Mounted Warrior efforts. In terms of Air, Land or Mounted Warrior, LTG Kern has a Mounted Warrior background and will certainly have the experience and assignment portfolio to expand development of VRD from aviation applications to the entire spectrum of Army battlefield information display requirements. Further evidence of Microvision's penetration of the Army's battlefield display requirements can be found in the helmet mounted VRD now under contract to the Army's Battle Command Battle Lab program at Fort Leavenworth. With delivery of this HMD, Microvision will provide the Army a display solution with immediate applicability to the FBCB2 program.
In valuing Land Warrior and FBCB2 one first needs to assume a level of probability that MIVS will capture the Army display requirement for these programs. My reading of the tealeaves leads me to believe that this probability is above 50%. Next one needs to estimate the price the Army will pay for Land Warrior and FBCB2 displays. Based on Army willingness to pay for night vision devices and similar displays I estimate Land Warrior VRD units would have a unit price in the $10,000 dollar range while FBCB2 VRD displays would cost the Army $20,000 per unit. Assuming a 50% gross margin and a delivery of 60,000 units by 2004, MVIS would garner annual revenues of $75mil/year through 2004. The expected EPS would thus be in the range of $3 per share.
Valuations of Army aviation requirements seem subject to far less uncertainty. Based upon recent news releases I believe that the probability of MVIS capturing Apache HMD requirements as a near certainty. Though LTG Kern's comments referred to the Comanche project, it is important to note that Boeing is now remanufacturing the Apache fleet. This effort is focused on upgrading Apache's flight management systems, weapons sensors and the crew – aircraft interface to the AH64D Longbow configuration. In this configuration the HMD is the key interface between the crew and the Longbow weapons system. This effort suggests another reason for the 1 March announcement of the Boeing-MVIS collaboration and the 8 March contract announcement of the Army VCOP contract.
The Army expects to remanufacture 750 Apache aircraft over the next 10 years. Boeing is now under contract to upgrade 232 Apache's to AH64D models over the next four years. The Army has decided to delay initial operational capability for the RAH66 Comanche until 2006 when Apache upgrade spending will subside. Given this information, most of the initial VCOP revenues are likely to come from the Apache modernization. Assuming a production rate of 80 aircraft per year and assuming an installed VRD cost to the Army of $250,000 per aircraft at a 50% gross margin, MVIS annual earnings for VCOP should be in the range of $1.00 per share.
Since the RAH66 is slated to replace the existing fleet of AH1S and OH58 aircraft on a 1 for 2 basis it is unlikely that the Army will apply a substantial upgrade to these older aircraft unless the RAH66 effort becomes unaffordable or substantially delayed. It is likely however that the Army would apply VRD technology to the UH60 and CH47 fleet. However, displays for these utility and cargo aircraft would not require the systems integration presented by the Apache effort. Additionally, while VRD in these systems would reduce pilot workload and enhance safety, it would not contribute to target killing capacity. Therefore, Army willingness to pay for VRD would most likely be less than in the AH64. Assuming a VRD cost to the Army of $125,000 per aircraft at a 50% gross margin MVIS earnings for the UH60 fleet would be about $1.00 per share per year over the period from 2000 to 2010.
For reference, the current and planned Army aircraft fleet is as follows. To provide a sense of Army capital invested in helicopters I have included aircraft procurement costs:
Aircraft Procurement Cost Number
AH64A/D $12 mil each 821
RAH66 $25 mil each 1200
UH60 $20 mil each 1500
OH58 $10 mil each 800
Total Army 4321
I hope the aforementioned assemblage of open source material is of some assistance to investors as they sort through news group postings. Over the past year those who follow the Yahoo thread have had to endure attacks on Rick R's character by Charlie Chan sound a likes, incessant storm warnings from Florida based bimbos and questions regarding “warrents” – what ever they are. Such nonsense is the background noise over which MVIS must make its vision of the future heard. Management has clearly done a superb job of perfecting VRD and marketing its technology to the military. It should also invest a modicum of its talent in conveying an effective visualization of Microvision's latent value to Wall Street. |
