For the past couple of months, my deepest conviction long idea has been Pro-Dex (PDEX). If friends, family, or other investors asked what I was into at the moment, my first answer was, “PDEX.”
Only recently have I begun to find other stocks that I like as much as Pro-Dex… at present prices.
Anyway, here are some of my own and others’ writings on the story over the past three months:
A thesis e-mail I wrote to some friends in late July:
“Nasdaq-traded Pro-Dex is a medical and dental device maker in Irvine, CA.
“A few years ago, their biggest customer decided to take design and production of their devices in-house. Pro-Dex management responded by paying themselves higher salaries while the customer purchased one last inflated build-up of PDEX devices. This customer accounted for 40% of PDEX sales at the time.
“Pro-Dex management also completely failed to cut costs despite full awareness that they were about to lose 40% of their revenue. Losses ensued. The stock dropped significantly and has dribbled around $2 for five years.
“In 2012/2013, two activist hedge fund managers bought significant amounts of PDEX stock and took control of the board. Their proxy letter from December 2012 is well worth reading. They got rid of the old CEO and promoted an insider to lead the company.
“Together, they began to implement structural changes:
- Most importantly, costs have been significantly reduced. This is easy to see from a simple glance at the past few years’ Statements of Operations.
- Compensation to board members was slashed to almost nothing. (Obviously Swenson and Cabillot believe they will make their money via appreciation in their large equity stakes.)
- Pro-Dex’s excess capital is now being invested by Swenson and Cabillot.
“With these changes in place, Pro-Dex has only one task left: to increase its decimated revenues. The sales cycle in medical devices is long and involves many meetings with prospective customers as needs are communicated, engineers design, prototypes are built, prototypes are tested and re-tested, until finally (hopefully) the customer says, “Yes, this is it. Make me 1,000 of these devices, please.”
“Pro-Dex has been in a multi-year research and development phase for a significant new drive for devices, which they have said for a while now could first bear fruit on the next quarterly earnings report, due in September. [Update: Actually, that date has been pushed back to fiscal Q3 which will be reported in May 2015.] If and when PDEX shows evidence that they are getting orders for their new devices, the stock will jump.
“The downside is fairly protected here (current price $2.14 [Update: Price at close today 10/27/2014 was $2.30]) because the tangible book value of the company is approximately $2.oo/share. Provided that losses continue to decrease and/or new sales begin to occur, I view it as highly unlikely that the stock will go much lower.
“This leaves us with a near-perfect scenario for an investor: a very small probability of a large drop in price and a healthy chance of a large gain in price… I like the risk-reward ratio here.
“The investment basically comes down to this for me: how likely do I think it is that Pro-Dex will increase their sales? My answer is this: Pro-Dex’s expertise is designing and manufacturing medical and dental devices. That is what they do. They have smart engineers, they are in this world of medical devices and know what customers are looking for. Their ship has been righted (costs cut, new controllers) and they will more than likely be able once again to increase sales by giving their customers what they are looking for. I see at least a 2/3 chance of this materializing – and a 100%+ upside if it does (with several multiples of the present price quite within the realm of possibility).
“If for some reason Pro-Dex has lost their medical device mojo, maybe there is a 30% downside.
“These are the rough calculations/probabilities which feel right to me regarding Pro-Dex.
“One further note: a couple months ago the company did a rights offering, offering all shareholders the right to buy an additional (newly created) PDEX share at $1.90. The two hedge fund managers maxed out their subscription rights (they bought as many shares as they were allowed). To see such a vote of confidence by Swenson and Cabillot should encourage a prospective investor about the company’s prospects. The shares are available for not much more than that even today, still.
“A successful turnaround seems likely – and then, nice profits for shareholders.”
Post on iHub PDEX board
On September 19, I posted my thoughts regarding Q4 and the conference call.
A briefer e-mail sent October 3rd:
“PDEX story has gotten better since I introduced it to you, yet price has barely moved up. I think it is a triple at least within a year. Very confident on this one. Company announced plan very recently to buy back up to 18% of shares outstanding over next 6 mos. [12/1/2014 UPDATE: On fQ1 conference call, CEO Hurwitz made it clear that PDEX would not be using up the whole 750,000 share buyback authorization, or anything close to it. Appears they have other ideas for the cash.] Everything comes together by May probably, when they report fiscal Q3 results, which CEO is guiding to be first quarter that shows revenues from big, new customers company has been working for years to get online. CEO, who is conservative in his talk, was notably less conservative (to my ears anyway) in last conference call. Then they announced share buyback. Earlier this year they did a rights offering which I had told you about which was really just a way for the 2 activists involved to get a larger percentage of the company (they WANT the shares) and now they will be using the proceeds from the rights offering (at $1.90/share) to buy back shares in the $2’s a mere months later. What this tells you is that the activists view the company/common stock as desirable and grossly undervalued, even if they are sneakily increasing stake over shareholders who opted not to participate in the (somewhat) sophisticated rights offering. This has been my deepest conviction idea for a couple months and conviction has gotten deeper with release of earnings and conference call a couple weeks ago.”
On October 22, Pro-Dex released a proxy containing a fair amount of commentary by CEO Hal Hurwitz. I actually thought his statements were less confident than those made on the conference call. In the proxy, he seemed to be managing expectations.
On October 24, Whopper Investments noted that a share buyback had begun.
Disclosure: PDEX is $2.30 at the time of this writing and I am long.