Tough to bet against Norsat

Benj Gallander and Ben Stadelmann
Wednesday, February 2, 2011

Our results for 2010 were pretty darn good. The President’s Portfolio had an annualized return of 29 percent, pushing the 10-year annualized return to 19.6 percent, and the new Vice-President’s Portfolio, started on January 22, 2010, had a 24.9 percent total return.

There is some overlap between the two portfolios — five stocks, to be exact. One might suppose that these select few may derive a special benefit from the union of Benj’s and Ben’s very best contrarian ideas. Not so. This group actually gained an average of about 6 percent. Of course, with such a small data sample, over a short period of time, luck’s random walk must be given its due.

One of these laggards that didn’t do any favours for our performance was Norsat International. We’ve both been quite keen on this Vancouver-based manufacturer of broadband communications equipment for a few years. When Amiee Chan became CEO in 2006, the company was in disarray, with declining revenues, heavy losses and a dangerously low level of cash on hand.

Not many women have clambered to the top in corporate Canada; fewer still have a Ph.D. in electrical engineering, accompanied by an MBA, and run a tech company. But Ms. Chan has proved to be more than an uber-nerd with a few patents in satellite communications under her belt; she has also shown herself to be a sharp manager, who has ably steered Norsat on a course towards financial stability and sturdy growth.

Like many small caps with solid balance sheets that don’t need to borrow money or raise capital, Norsat has suffered from the benign neglect of analysts. That may change, as Ms. Chan recently announced a deal to push the company up a level. Norsat acquired Sinclair Technologies, a manufacturer of antenna and radio frequency conditioning products, for $19.25 million (US). In one fell swoop, this will almost double annual revenues to over $40 million.

Sinclair is no effervescent startup; it is an established leader in its niche, earning $2 million last year. That works out to a P/E of under 10, very reasonable for a growing tech company. The stars are aligned to make this an ideal time for Norsat to employ leverage. The $12 million loan is for four years at about 4 percent interest — dead cheap. From a macroeconomic point of view, the timing is auspicous; it makes more sense to make an acquisition at the end of a recession than at the beginning of one.

The term “synergies” gets tossed about in most mergers, but it is a vague concept that can cover just about anything under the rubric “The whole is greater than the sum of the parts.” Frequently, economies of scale are promised by cutting administrative duplication and overhead. In practice, the savings are tough to realize — severance payments increase expenses, at least in the short run, and the disruption and culture clash between the acquirer and the acquired can lead to acrimony, inefficiency and the loss of key staff.

Ms. Chan talks about synergy, too, but in a narrower marketing context. Sinclair has a lot of customers on the municipal government level, in areas such as emergency response, law enforcement and disaster recovery. Norsat has gear to sell into that market. Both companies have experience with supplying militaries with remote communications; together, they can provide an attractive suite of products. But overall, she has stated that the plans are to mostly leave Sinclair alone to do its thing. Well-run, lean companies don’t need to be torn apart and reconstituted in a frenzied search for savings.

Any way you cut it, there’s no getting around the fact that this is a huge leap for Norsat, creating inherent risks. Ms. Chan has already had a remarkable career; this is her chance to truly prove her mettle. Based on her previous results, it would be difficult to bet against her, and we believe this stock could triple from the current level under 70 cents.