Tuesday, October 17, 2006
Eternal Technologies' (ETLT) primary business shrinking
because the company has been so successful in the transfer of embryo's in the PRC, that the business is now declining as numerous farmers are using their own stock (which had previously been implanted with foreign embryos) for breeding purposes. Accordingly, the demand for embryo transfers and the pricing is declining. As a result, the company is seeking new opportunities in its agricultural division.The market is now reacting to the loss of the primary business, which makes a lot of sense. If the embryo business goes away, the company becomes nothing but E-Sea, a bunch of cash, and some people looking for acquisitions. However, you've got E-Sea's original business producing about 2.5 cents per share. You've got E-Sea's new business which will produce maybe another 2.5 cents per share (that was my assumption back in Feb). Then if the $40 million in cash can be invested to produce 5% per year, that adds another 5 cents per share for a total of 10 cents per share.
This shows why having a large margin of safety is so important in investments like this. ETLT doesn't need to hit a home run with investments in a new business in China.
I continue to own the stock. If anything, this clears up a big red flag in my mind about their various announcements of potential investments outside the primary line of business (crouching tortoise, hidden mango). And when it became clear later that these things were just under consideration and not done deals, that also made it easier to deal with. Someone on the Raging Bulls message board was apparently at the shareholder meeting and said good things that match what I would have expected.
UPDATE Oct 18, 2006:
Here's more of my opinions.
The value of ETLT has changed, but it's not as bad as it looks. The cash flow stream from the embryo business is now worse than it appeared before. Right now, here's the business:
1) Declining embryo business with decreasing revenues and margins which will more or less end in about a year or two. Maybe it's worth 10 to 20 cents per share at this point based on how much [time discounted] free cash it will deliver going forward. But that value is totally dependent on management's ability to re-invest (see #3).
2) Expanding E-Sea business which will probably deliver a good free cash stream going forward, starting with around 2.5 cents per share per year and going up to perhaps 5 cents. That's probably worth around 40 cents at a minimum.
3) Whatever kind of return management will get from around $45 million or so in cash. This is not the same thing as valuing the cash itself since it's almost certain to be invested by management and shareholders will own the returns on the investments. This part of the business is better than a venture capital situation since they plan to acquire a functional business rather than starting one up. But it's still far from a sure thing.
Item #2 is huge because it puts a fairly solid floor on the value of the stock. For item #3, shareholders must evaluate management's ability to invest in new businesses and run them effectively. Right now the market is assuming the return from the investments will be terrible. It's treating each dollar's worth of cash in the hands of management as being worth about ten cents. So far, it seems that E-Sea was an outstanding investment. We've also seen management turn down potential investments based on projecting a lower than desirable return. As I've said before, they don't need to hit a home run with future investments. To beat the market's expectations, they simply need to destroy less than say 90% of the value of the cash they're holding. The bar is pretty low right now.