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Value Doc  Dr. Michael Burry Print-friendly
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Dr. Michael Burry   Michael operates on out-of-favor industries to find best-of-breed companies trading at steep discounts.
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Journal: August 15, 2000
•  Place order to buy 400 shares Deswell Industries (DSWL, news, msgs) at a limit of 13.75.



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Deswell Industries -- solid gold
Deswell Industries (DSWL, news, msgs) is a contract manufacturer of metal and plastic products as well as electronics. Traded on the Nasdaq but based in Hong Kong, Deswell runs an efficient operation that employs such techniques as on-site dormitories for its workers -- tactics that are profitable but not generally practical in the United States. One might consider this as a competitive advantage, but as a small company based in China, the firm’s shares are met with distrust and general avoidance. While the stock trades daily, the volumes are miniscule.
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Common products made by Deswell include printed circuit boards, telephones, computer peripherals, and electronic toys which are sold to original equipment manufacturers that brand the end product. Hence, Deswell is behind the scenes -- Vtech Holdings (VTKHY, news, msgs) and Epson are major customers. Deswell has a reputation for timely, efficient operations and has been winning larger and more numerous contracts over the years. Business with Epson is expected to triple over the next year, and business with Vtech is experiencing solid growth as well.

Deswell is a growth company but pays a generous dividend. Its officers own the majority of the stock, and rely on dividends as a partial salary replacement. Why? Dividends are not taxed locally. What this means is that in the long term, Deswell shareholders receive a quite generous payout every year -- often approaching double digits. And we can count on the dividend being preserved.

But excellent working capital management -- the latest quarter’s 47% increase in sales came with less than 20% increases in inventory and accounts receivable -- keeps cash flow so strong as to continue funding quite significant growth. This is not often seen in companies with high dividend payouts.

Show me the business
You can see where this is heading. CEO Richard Lau pays little attention to the stock price, preferring to focus on the business. Investor relations is farmed out, and institutions generally ignore the company. What all this adds up to after backing out the $5.33 per share in cash is a stock trading at about $8.50/share after earning $2.01/share over the trailing four quarters -- and quite a bit more than that in free cash flow. This despite recent revenue growth in the 40% range and additional growth expected for the foreseeable future. By the way, the cash on the balance sheet is held in U.S. dollars.

The malaise in the stock over the last few years has been linked to difficulties in its electronics operation, but the latest quarter saw an 80% revenue jump in that division. Mr. Lau expects continued strength there as the market for portable communications devices heats up. Moreover, Deswell is attaining a critical mass in terms of capacity -- the company is increasingly seen as a realistic option as a contractor on even very large jobs. The expected 250% growth in Deswell’s Epson contract over the next year is evidence of this. Expansion is being funded out of cash flows.

Another concern hovering over Deswell has been the effect of the rise in petroleum prices on its plastics business, which depends on resin as major input. But management hedged its supply such that there was no material effect on the business despite the parabolic rise in oil prices. This is a smart move, indicative of management’s savvy in its field.

Contract manufacturers as stocks are split into quite disparate valuation categories based on size. Deswell trades at an enterprise value/EBITDA ratio of 2.7. Solectron (SLR, news, msgs), with sales 200 times Deswell’s, trades at an enterprise value/EBITDA ratio of 30. Plexus (PLXS, news, msgs), with sales ten times Deswell's, trades at an enterprise value/EBITDA ratio of 40. And Deswell's return on capital and equity are quite a bit better than these other firms. The potential for multiple expansion with growth in revenues is hence quite significant.

I am looking to buy 400 shares at a limit price of $13.75.

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