Saturday, December 5, 2009

Stupid Cheap?

That's how Aaron Edelheit ("issambres839") describes shares of Destiny Media Technologies (OTC BB: DSNY.OB) in his latest comment on the Value Investors Club:

I estimate that Destiny can earn 5 cents a share in fiscal 2010 (ending August 31st), on at close to 100% revenue growth. The revenue growth will be driven by more music being sent digitally and an increase in their international business. Destiny only trades at around 8 times my earnings estimate, despite tremendous growth and operating margins around 50%. Operating margins in the last quarter were already 34% and trending higher. That is why the company announced a buyback as well. I expect Destiny to continue to announce great results and the share price to keep bouncing higher.

This stock is stupid cheap.

Attempting to value a company based in its future earnings makes sense, particularly for little-followed micro caps such as DSNY (or AYSI1, for that matter). If you think you can see future earnings that the market hasn't priced into the stock yet, you can profit by buying the stock now, before those earnings materialize and the market values the stock accordingly. As Niels Bohr said though, "Prediction is very difficult, especially if it's about the future.". For an example of that, let's look back at what Edelheit wrote about DSNY at the beginning of 2008:

Trading at seven times my fiscal 2009 (ends August 31st) earnings estimate, Destiny Media with its 90% plus gross margins and recurring revenue stream is a undiscovered gem for both technology and value investors alike.


The company currently has a market cap of around $30 million. Assuming my revenue estimate of $11 million is correct, the company will earn $0.10 in pre-tax profits in fiscal 2009. The company should probably be valued at a multiple of 15 to 20 times that number. That would give you a valuation of $1.50 to $2 per share.

Using a price to sales measure on $11 million, 10 times price to sales for a 90% gross margin, highly recurring business seems fair, giving the company a value of $2.11 per share.


If the company can continue to grow to my revenue estimate of $16 million in 2010, it will earn $0.20 per share, making $4 per share an easy target in 18 months.


Whether the stock goes to $2 or $4 is really a moot point with the stock at $0.68 per share.

So, two years ago, Edelheit predicted that DSNY would earn 10 cents a share in its fiscal 2009 (and 20 cents in its fiscal 2010). It ended up earning 1 cent per share, in its fiscal 2009, most of which was the result of a refund of previously paid taxes. I don't fault Edelheit for getting those predictions wrong -- like Niels Bohr said, predictions about the future are tough. But I don't see how confident he can be in his current earnings prediction. Edelheit seems unchastened by his 2009 predictions being off by an order of magnitude. I tried to ask him about this on his blog, but for some reason my comment didn't post.

To reiterate a point I've made here before about Destiny Media Technologies, I like the company's story, and it has been moving in the right direction recently by becoming profitable, growing its revenue and earnings, etc. My concern is its price relative to its future earnings.

1I could certainly be off with AYSI, but the math seems simpler and clearer to me in its case. During its best quarter it earned 6.8 cents per share. That was with one mill running at full capacity. Now it has two mills running at full capacity, spurred in part by a long-term supply deal with one of the largest mining companies in the world. Let's say the company earns 10 cents per quarter next year with two mills running at full blast. Annualize that and give it a 10x multiple and you have a $4 target (that doesn't take into account the other two mills the company says it plans to build, its recent deal in Indonesia, other possible business, etc.). An exogenous event (e.g., China's economy falling off a cliff) could nix that scenario, but in the event that doesn't happen, I doubt my low-end prediction of 40 cents in 2010 earnings will be off by a factor of ten. We'll see though.


Aaron Edelheit said...

Dave, I think you are absolutely right to bring up past projections that were wrong. On forecasts in 2007 and 2008, I was way too optimistic about the earnings forecasts for DSNY and PNI Digital Media. On both of these companies it just took longer than expected to get contracts up and running and dealing with larger companies.

I have tried to be more conservative and realistic going forward. DSNY for example is already at a $4 million revenue run rate and that is without any new contracts signed. Plus their business contracts now have monthly minimums, so there is no drop off seasonality like there was in the past.

$5 million in total revenue at 50% operating margin, equals 5 cents. That said, I could be too optimistic again, but I think DSNY is finally showing proof.

Good blog post and keep up the good writing.

DaveinHackensack said...

Thanks, Aaron. We'll see what happens.

DaveinHackensack said...

Turns out 2010 earnings for AYSI were 28 cents.