Friday, August 13, 2010

Net-Net Idea: Defense Industries International (DFNS)

I wrote earlier about the pitfalls and potential opportunities of net-net stocks. Well, I've come across what I think could be a winner. The name is Defense Industries International, and it's a tiny (and I mean tiny) Israeli manufacturer of civilian and military personal protective equipment. This is mostly body armor, but they also sell things like shields, tents, ballistic wall covers, and collapsible liquid containers. Its largest customer is the Israeli military, but it also has a diverse client base across North America, Europe, Africa, and Israel in both the civilian and military markets.

Test #1: Does It Make Money?

Like I said before, this is a small company, but a profitable one nonetheless. Over the past five years, it's averaged only about $15 million in revenue and a couple million in net profits and free cash flow. The growth isn't really anything to write home about either. Over those five years, revenues have grown by a total of about 55%, but the last year has shown a slowdown, naturally due to the poor condition of the worldwide economy. Also, it doesn't seem like a lot of these revenues are recurring, and the company is fairly dependent on business from the Israeli military.

Test #2: Are The Assets Valuable?

In a word, yes. Defense Industries has about $14 million in current assets, half of which are cash or short term investments. It only has $4 million in inventory, which I highly doubt will become obsolete anytime soon. As far as liabilities, the company has about $5 million in total liabilities on its books, almost none of which is long term debt. In net-net terms, this leaves a net current asset value of anywhere between $6 million and $8 million, depending on how conservatively you want to value the assets.

Test #3: Is It On Sale?

As of recently, Defense Industries International has a market cap of under $3.4 million ($0.12 share price). With about $7 million in net current assets, a million in earnings, and some extra PP&E that wasn't included in the net asset calculation, it looks like this could be a steal.


Of course, rarely is a net-net a complete slam dunk. There are clearly huge risks with a stock like Defense Industries, even if it does look like a bargain from the financial statements. First and foremost, it is a miniscule company that is up against much larger competitors that sell the same if not superior quality products. Its revenue base is diverse, but that does not mean it is particularly strong. This could mean that the slim profits could quickly turn to losses, eroding those valuable cash reserves. Furthermore, the stock trades very thinly and has lately been in a very tight range. Shares might only change hands once or twice every other day. Additionally (and probably most troubling to outside investors), the chairman owns about 70% of the stock, so the company is essentially at her mercy.

However, I think that the company does have a potential catalyst. I believe that the fact that it is in Israel and sells to the military there offers some upside potential considering the country is seemingly in a perpetual state of war. This might not mean much, but I certainly believe this fact coupled with the enticing valuation warrants some additional research on Defense Industries International.