This is not investment advice. This post is presented for informational purposes only. Before buying a security, please do your own research. Please note that the author’s fund has a position in the security mentioned in this post. Please read our blog's full disclaimer.
This work was originally published on SumZero on November 26, 2021.
CompuLab (CLAB:IT) Investment Thesis
"These are among my favourite investments: small, aggressive new enterprises that grow at 20 to 25 percent a year. If you chose wisely, this is the land of the 10- to 40-baggers, and even the 200-baggers. With a small portfolio, one or two of these can make a career."
Peter Lynch, “One Up on Wall Street”
Elevator Pitch:
A highly profitable and free cash flow generating hardware manufacturer, temporarily impacted by a global chip shortage and supply chain disruption, Compulab is poised for secular growth while shares can be bought for a very undemanding valuation.
Current price: 18.72 NIS per share
Target price: 40 NIS per share, 114% potential upside
Executive Summary:
- * Founded in Israel in 1992 and public since February 2021, Compulab trades on the Tel Aviv Stock Exchange (TASE)
- * Compulab is an Israeli micro-cap, with a current market cap of 170 million NIS (~55M USD)
- *Compulab was founded by Gideon Yampolsky, who serves as CEO and Chairman of the Board and owns 70.25% of the company
- *Compulab became a public company in 2021 following a private equity shareholder’s need to liquidate its holdings; we note that founder-owner-operator Yampolsky did not sell a single share in the IPO
- *Compulab has two lines of business: 1. A high-growth operation designing and manufacturing Computer-on-Modules systems (CoM’s), and 2. A legacy slow-growth operation designing and manufacturing miniature industrial computers
- *Compulab’s business model relies on negative working capital, so earnings are primarily converted into free cash flow – there is no need to increase working capital to finance growth
- *2021 half year results were impacted by what we see as temporary Covid-19 chip shortage and supply chain disruption issues – we believe they are not representative of future growth potential or true earnings power
- *We believe current market price implies one can buy shares of Compulab for a 7.5 free cash flow multiple for expected 2022 results
- *Valuation is very undemanding for a company we believe will double sales in the next 3 years and will triple its pre-Covid earnings
- *Strong downside protection is embedded in Compulab’s balance sheet as it has a net cash position of ~22 million NIS and an office building owned by the company worth 35-45 million NIS
- *We view Compulab as a unique, profitable, cash-generating growth story and believe it will appeal to micro-cap investors as the future will reveal Compulab to be a secular growth story
Israel’s currency is the New Israeli Shekel (NIS) ₪. 1 USD = 3.1NIS as of November 23, 2021
The term CoM in the industry is sometimes replaced by the term SoM (System on a module). They are synonyms.
Compulab and the Computer-on-Module (CoM) market
This is an example of a machines that uses a CoM as a building block:
What is a CoM/SoM?
From Wikipedia [sic]: “A system on a module )SOM) is a board-level circuit that integrates a system function in a single module. It may integrate digital and analog functions on a single board.”
In other words, the modules are electronic boards on which main components of a standard electronic system, such as a central processing unit (CPU), microcontrollers, memory, audio, and video cards, are installed. The CoM niche market is part of the broader computer board market.
Clients who buy CoMs are hardware manufacturers designing and producing electronic products. A client will buy a CoM from Compulab for use as a building block for another electronic product, such as a tactical GPS navigation unit, smart glasses, a coffee machine, a treadmill, or a medical ventilator.
Clients typically buying an off the shelf CoM need to design and manufacture up to 50,000 units of a hardware product. Above that number, it is usually more effective to develop the module internally.
How does a CoM client interact with a company like Compulab?
Let’s use an example of a client designing a medical monitor able to communicate in real time with various medical sensors and to display all the data graphically on a screen. The client finds a generally suitable CoM from Compulab’s existing catalogue then orders it online with a process of customization. For example, perhaps the client would like the monitor to transmit data wirelessly, so a relevant component will need to be added to the CoM.
Following customization, the client pays an advance of 50% of the order value and then the order moves to production. Once a client chooses its CoM supplier, it is basically locked into using the same CoM for as long as the product is manufactured, as replacing a CoM is an expensive and potentially harmful process.
Typically, a CoM unit is sold at a price range of $50-$80, a fraction of the cost of manufacturing a product that uses an CoM as a building block. That by itself is another incentive not to replace a CoM once it is embedded in a hardware product.
What is Compulab’s CoM sector growth trajectory and what percentage of overall sales does it represent?
Historically Compulab was a pioneer CoM manufacture, and company sales grew from 0 in 1992 to ~10 million USD in 2004. This growth was achieved solely from internal cash flows. No borrowing was required, and there was no need to sell equity in order to raise cash.
In 2004 Compulab pivoted to manufacturing mini-PCs, a high growth industry at the time. By 2014, the mini-PC industry was slowing, and in 2015, the company pivoted back to the CoM industry. In 2020 CoM represented ~57% of revenue, and between 2017-2020, Compulab’s CoM revenue increased at a CAGR of 17%.
The initial selling process with a client starts with delivering an evaluation kit. Compulab refers to such a sale as a “design win.” It takes approximately 2-3 years from a design win until a client completes the process of designing a new product using Compulab’s CoM as a building block.
Design wins are up 46% since 2017, from 298 design wins to 435 during 2020, and cumulatively 1,207 design wins between 2018-2020. We believe that number implies an acceleration of growth rate to be more than 20% for the coming years in the CoM segment.
As CoM sales grow, Compulab will have a higher percentage of overall sales.
How big is the CoM market?
Estimates range between $1.5B to $3B annually, and we prefer to use a $2B estimate that indicates that Compulab has ~1.5% market share. The industry itself is quite fragmented, with several hundred small and medium-sized manufacturers worldwide. It is also estimated that the market will grow 20% annually for the foreseeable future.
Miniature industrial computers segment
The miniature industrial computer line is Compulab’s legacy business. The minicomputers are compact and use technology that doesn’t require a ventilator for cooling. Therefore, as the minicomputers do not spit particles to the air and can endure harder working environments, they are relevant for industrial applications. Common applications are in medical manufacturing lines and in fast food restaurant kitchens. We expect the minicomputer line to grow sales at a low single digit rate for the coming years.
We note that Mr. Yampolsky, Compulab’s founder, is known for emphasizing and investing great resources in R&D. The company has several other product lines, and as some of them could be successful in the future, there is some embedded optionality to the thesis.
Management and ownership
Compulab was funded by Gideon Yampolsky in 1992. Mr. Yampolsky, 60 years old, serves as CEO and Chairman of the Board owning 70.25% of the company.
Mr. Yampolsky’s salary is relatively modest in comparison to Israeli industrial companies of Compulab’s size. According to his current contract, employing him costs Compulab 1.4 million NIS annually (~450K USD).
The ratio between the market value of Mr. Yampolsky’s holdings in Compulab and his salary is 86, and we think this implies an alignment of interest between him and passive minority investors.
Some clues to Mr. Yampolsky’s character can be found while reading the 2020 annual report. In the second part of 2020, Mr. Yampolsky drastically lowered his compensation for 2020-2021. We believe this is a response to Covid-19 business disruption and an example of Mr. Yampolsky’s leadership style and commitment to the company he founded.
In 2012 Mr. Yampolsky sold a portion of the company to a local private equity fund and private investors. They eventually built a 29.25% stake in Compulab. In February 2021 Compulab completed an IPO on the TASE. The sellers were the private equity fund. Mr. Yampolsky did not sale a single share in the IPO.
Part of our bullish thesis is based on the scarcity of Compulab’s share float. Only 30% of the shares are available for the public, some of which is already held by long-term investors like us. That means that the public float available is currently worth ~50 million NIS (~16 million USD).
It is our belief that once Compulab’s growth story will manifest in the financial reports, there will be a high demand for Compulab’s shares. Demand plus scarcity will create a strong back wind for share price appreciation.
Operations and Financial Results
The following table summarizes Compulab’s key financial data from recent years:
Essentially, up until Covid-19, the modules (CoM) business was growing at a very healthy pace. H1 of 2020 even saw a large, exceptional Covid-19 order of modules for respiratory machines. That helped end H1 of 2021 with 10.5 million NIS net earnings, a figure close to the entire net earnings figure of 2020.
Following its IPO, in March 2021 the company published its 2020 annual report. H2 of 2020 was very weak compared to the first half, as Covid-19’s impact was harming business. Investors grew skeptical with the fear that the well-timed IPO was trying to conceal a weaker earnings power that was not apparent during the road show.
We have spoken to management and industry participants and take a different perspective: Covid-19’s related chip shortage and supply chain disruption are making it difficult for Compulab to produce and to deliver finished products, and from an accounting perspective, revenue can only be recognized once a product is delivered to the client, demand for Compulab’s products is strong and we see this evident in a massive spike in backlog.
Compulab’s backlog has surged from ~21.4 million NIS on December 2020 to ~71 million NIS in August 2021. This 230% increase suggests exceptionally strong demand. Further, since the company sold products for ~43 million NIS in H1 2021, this also suggests to us that as the chip shortage eases and products will be supplied to customers, Compulab will recognize historically high revenue and investors will start seeing Compulab for what it really is: a growth company.
Valuation
This is our model for the coming years:
We believe that in 3 years’ time Compulab can earn ~27 million NIS annually and produce more than 30 million of FCF per year while growing.
Compulab is known for investing in R&D, perhaps at a level higher than expected for an industrial company of its size. Following Q&A with management, we believe that the company can grow revenue to 160 million NIS without a need to increase operating costs. R&D can remain stable. Compulab owns the building in which it operates and is currently utilizing only 85% of it so there is more room for production lines.
From this point onward, we believe this is an operational leverage story. As Compulab’s sales grow, the bulk of growth will go directly to the bottom line.
We also note a strong balance sheet downside protection embedded in the Compulab story. It has 21.8 million NIS net cash on its balance sheet and owns its own building, with an estimated worth of 35-45 million NIS (our own estimation of the building’s current market value). We view these data points as a signal of strong downside protection for a 170 million NIS market cap company. We also note that Compulab operates in a favorable local geography in Israel, allowing the company to enjoy very low to nonexistent corporate tax.
Tying it all together we take a discounted future cash flow approach, discounting all future cash flows at a discount rate of 10%. Using 2024 as a terminal year with a 2% perpetual growth rate, we arrive at a 40 NIS value per share that we use as our price target.
As a sanity check we apply a P/E of 15 for 2024 with an estimated 3.16 NIS earnings per share and come up with a higher price target of 47.4 NIS per share. We believe this is a rational multiple, as Variscite, the closest comp, trades at a P/E of 16. For a deeper comparative look at a more mature company in the CoM industry, one can look at our Sum Zero write up on Telsys and its subsidiary Variscite.
Key Risks
Key risks include:
- *Geopolitical risk: A round of violence between Israel and its neighbors could result in difficulties shipping products out of Israel
- *Increased competition and low barriers to enter the CoM niche
- *Supply Chain challenges and chip shortage may be long-term problems preventing Compulab from reaching its full potential.
- *Key man risk- Compulab has a dependency on its founder-owner-operator
Conclusion
We believe Compulab is a compelling opportunity to invest in an under the radar, off the beaten path secular growth story, led by a capable owner operator with ample of skin in the game. Once supply chain disruptions resolve, Compulab’s financials should display a unique mixture of growth and improving profitability leading to Mr. Market revaluating share price.
Embedded into the idea is strong balance sheet protection in the form of assets worth ~36% of market cap.
Relevant Links
- Compulab’s web site
Compulab’s page on the TASE
Disclosure: Anafa Capital is LONG Compulab (CLAB:IT)
