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Technology Stocks : Deswell Industries (DSWL) -- Ignore unavailable to you. Want to Upgrade?

To: Michael Burry who wrote (638)	4/11/1998 12:14:00 PM
From: Ron Bower	Read Replies (1) \| Respond to of 1418

Mike, Definitely need the bear! But... To further examine Deswell's operation (beware, it's a long post): If the customer has to pay an upfront charge on the plastic, wouldn't this also apply to set up costs for Kwanasia and Kwanta? Kwanasia would have to design circuit board production and the machines that apply the components. They then would have to train employees and layout the assembly line for assembly of that product. This would entail a high initial cost followed by low production costs. The same would apply for Kwanta and the stamping of metal parts for the product. Each contract requires substantial upfront monies from the customer. With Deswell, they pay for the plastic, the metal, the boards, and the assembly to one customer instead of a variety of customers. Very few companies offer this combination without involving other suppliers. The only shipping involved prior to product delivery is for the board components, items shipped by thousands in a small package. My point is that once they sign a contract with an OEM customer to produce a product, unless that product is discontinued, Deswell will have an ongoing relationship with that company. If they had not gotten into assembly, they wouldn't have as strong a lock on the customer. By doing it all, with the exception of components on the board, they insure themselves of continued business providing they keep quality high and prices low enough that the customer won't look elsewhere. While we might be concerned about the small list of customers, it appears to me that each added customer is not a one time contract. As the list grows, they aren't replacing business lost to former customers, but adding to existing and future. A contract for a 10% increase in revenue is very likely a contract that will be ongoing over a period of years. If that customer is satisfied, contracts for new product designs would result. In many cases, only slight modifications are made to a design and this would be far cheaper to do thru Deswell than to seek another supplier. By the same token, a customer lost may be lost forever. They must have the capacity to insure delivery to existing customers and know that the capcity will be there when seeking future business. This may mean that the facilities recently acquired are not for existing contracts, but to enable them to take on more business. Behringer and the other old accounts are stable (except Namtai), InterTel and Harmon are growing fast, but I think the V-Tech account may have the most potential as they market a large variety of products. So far, Deswell is producing telephone related, but there's a lot of opportunity with the V-Tech account. Hate to do it, but (IMO) I'm adding reasons to be bullish. For what it's worth, Ron PS. I'm applying a lot of this same thinking to HIHOF and AEHCF.

To: Michael Burry who wrote (638)	4/15/1998 4:44:00 PM
From: kolo55	Read Replies (3) \| Respond to of 1418

The "Yellow Bear" case. You wrote: Dang we need a black-as-all-hell bear on this thread. OK, I'm not a black bear, not even a bear on this stock, but I'll put put forth the bear case recently suggested to me by that noted short seller "Yellow Bear". As mentioned way back when on this thread, the key to this stock is the high margins Deswell gets, especially compared to similar companies in the businesses Deswell is in. The current market cap of $110M divided by trailing sales of $57M, so trailing PSR is close to 2 - Not cheap on a trailing PSR basis. Using Ron Bower's number in post #630, the MarQ will be about $18M (a $72M run rate), and using that run rate ol' Yellow gets a PSR of 1.50. Looking forward, let us conservatively assume the following sales for the next four quarters, which add to roughly a 30% growth from 97DecQ to 98DecQ: JunQ $20.0M SepQ $22.5M DecQ $24.7M 99MarQ $23.4M Forward 12 month total= $90.6M Forward PSR= 1.20 Bottom line is that this stock is not cheap on a PSR basis. But look at the earnings Deswell gets from that revenue stream. Over the first three quarters of the 98 fiscal year, their AT net income is over 20% of revenues. In fact if ol' Yellow read the P&L correctly, they seem to be reporting minority revenues in their reported revenues, then backing out the portion of the net income that goes to minority interests before reporting EPS. So it looks like this company gets over 23% AT margins on their sales. This is a terrific margin, seemingly too good compared to similar companies. But this generates the beautiful earnings stream that has attracted honeybees to this stock. A bear would question this margin, and go on the prowl looking for honey. First, are the profits for real? Remember...earnings are easier to fake than revenues!! Based on an analysis of the company's financials, even Yellow believes the earnings are real. The company is being audited per US GAAP standards, and the financial statements seem consistent over a long period of time. Nevertheless, this is the kind of question a company in this position should be asked. We've seen several cases in this sector where outsized margins were due to accounting sleight of hand, and outright fraud (Centennial Technology). Given the foreign origin of the earnings, Yellow thinks the market will always place a risk factor on such terrific margins and discount them to some degree. Second, is this outsized margin sustainable? ...Are competitors about to move in on this lucrative market? A bear may have to wait until a storm knocks the honey tree down, before he can steal the bees honey. Given the Asian crisis, it is reasonable to expect that competitors will eye Deswell's fat margins with envy and attempt to move into this market. So Yellow thinks we could see a margin shrink. How bad could it get? Yellow noticed that Ron used a margin of about 18% in his estimate for the MarQ. His guess is that a reasonable downside is 12% with a worst case of 8%(disaster case). What will that do to EPS? Using the 30% growth case revenues of $90.6M, and margins as follows: Best case: 20% margin $3.30 per share annually Reasonable cases: 18% margin $2.96 15% margin $2.47 Downside case: 12% margin $1.97 Worst case: 8% margin $1.32 Of course, if growth stays up in the 40-50% range, and margins stay up in the 18-20% range, then Deswell will see some great earnings growth, and this stock is cheap. But if hoards of competitors suddenly move in on their business and revenue growth and margins shrink, the stock will react negatively. Yellow thinks this fear is keeping some people from buying this stock. And given the plant visit scheduled for next week, these timid people may find that their fears are overblown. So Yellow isn't shorting yet, he'll wait until he sees Deswell's plant and asks management about all these competitors. Then he'll chase all the Deswell holders into the woods. For me, I don't buy Yellow Bear's case. I think Deswell's customers are quite loyal, and relatively locked in for a number of reasons (cost of shifting production, ownership of Deswell shares, China still has lowest costs in Asia, delays in getting a competitive operation up and running, minor cost structure change not as important as time to market etc.) So seems to me, that this stock could get a boost after the analyst visits next week. Paul