Summary
- DPSI provides digital mobile solutions for various industries. Its products include RFID printers and scanners, ruggedized mobile phones and tablets, mobile workstations, etc.
- The company's process optimization business has long sales cycles, is relatively non-recurring, and has undesirable competitive characteristics.
- DPSI was relisted in 2021 after a scandal related to its then-CEO in 2015. The company dedicated then to the same business and generated massive losses.
- Today, the company is recapitalized, but its business economics have not changed. Recent one-time, unexpected hardware orders have elevated revenues, which have multiplied at the bottom line thanks to operating leverage.
- I believe that the company is expensive at these prices in terms of historical and more recent (probably non-sustainable) profitability.
Decisionpoint Systems ( DPSI ) provides digital mobile solutions for various industries. Its products include RFID printers and scanners, ruggedized mobile phones and tablets, mobile workstations, etc. The company does not design or manufacture the products but resells them with process improvement solutions.
DPSI was relisted in 2021 after it was delisted in 2015. Since then, it has grown revenues, although most of the new business has been eaten away by SG&A expenses, among which managerial compensation ranks first.
The company saw a recent increase in profitability because of record hardware orders from two customers, compounded to operational leverage. However, without these transactions, the company's profitability is low.
In both cases (considering or not recent profitability), the company trades at earnings multiples that are not justified by company quality or growth perspectives.
Note: Unless otherwise stated, all information has been obtained from DPSI's filings with the SEC .
Business description
Process optimization services not a great industry : DPSI offers companies the design and implementation of mobile solutions for their processes. This includes hardware and software solutions, usually designed and manufactured by other companies.
In some sense, the company's market is similar to that of Orion Systems ( OESX ), a company I wrote recently about. These businesses do not have the best competitive characteristics.
The business is not exactly recurrent because once solutions are implemented, the only recurring revenue is the repurchase of hardware and consumables. A reader described this kind of business as a go-get them because the company must consistently renew its customers.
Because the company does not design or manufacture the components of its solutions, barriers to entry are low, which increases competition.
Finally, customers are companies that usually have more bargaining power. Customers have a yardstick on which to compare the solution's value. For example, if the company proposes a new checkout system to a retailer, the improvements are easily measurable in terms of speed, cost, etc. This puts a ceiling on how much the customer is willing to spend on the solution.
Relisted company : DPSI was delisted in 2015 after its CEO was accused of not disclosing trading activity, its auditor resigned , and the company breached covenants on portions of its debt. Back then, the company was in the same business (process improvement solutions in mobility, logistics, and supply chain), generating losses at a rapid rate of $7 million in FY13 .
DPSI was relisted in 2021 after managerial changes, a recapitalization, and the disposition of the logistics and supply chain solutions segments.
Growing but losing profitability : Since its relisting, DPSI has not been growing revenues significantly, at least until the last two reported quarters. However, its operating income was getting worse and worse.
The cause, as usually happens with this type of company, is that SG&A expenses were growing much faster than revenues.
High managerial compensation : One of the main factors in the increase in SG&A was outstanding managerial compensation in FY21. The company paid its CEO a salary plus a bonus of $700 thousand and then share-based compensation for $2 million as part of renegotiating its employment contract. Although the $2 million might be a non-recurring payment, in FY21, shareholders made $1.4 million in net income , half of what was paid to the CEO. This seems imbalanced.
Financially strong : Overall, DPSI is in a strong financial position. The company carries no debt and $9 million in cash reserves as of 3Q22.
Recent developments
One-time order fuel revenues : The company posted two very good quarters in 2Q22 and 3Q22 . These have shown revenues 40% above the ones generated in 1Q22 .
According to DPSI, these revenues were primarily generated by unplanned (this is the word used in the MD&A for 2Q22) hardware orders by two customers. Hardware represents more than 90% of the variation in revenues.
I believe this increase in revenue is not sustainable for three reasons: first, historically the company has shown cyclical revenues; second, the company's industry has a tendency to non-repeat business because of its project-based nature; and third, the company mentioned that the sales were unplanned.
However, in the valuation section, I assume that the current level of revenues and profitability is sustained. Even under this assumption, DPSI is not an opportunity.
Operating leverage multiplies profits : With SG&A expenses relatively stable for the last two quarters, the gross profit increases moved to the bottom line. This signals the level of operating leverage of the company.
While DPSI generated close to $0 operating income in 1Q22 with $4.3 million in gross profits, it generated $2 million in operating income with $6.3 million in gross profits in 2Q22 and $1.5 in operating income with $5.8 million in gross profits in 3Q22. There was a 1:1 relation between the two profitability measures.
Unfortunately, operating leverage is a double-edged sword. A $1 million decrease in quarterly gross profits implies a $1 million decrease in operating income because SG&A expenses are much more sticky than CoGS. Of course, SG&A could be scaled down eventually, but this is not the usual, particularly for companies with low repeat business, like DPSI.
Valuation
Current profitability : If we consider that the recent revenue levels are sustainable and that the company will keep in line with its SG&A expenses, then it should be able to generate about $7 million in operating income, which translates to about $5.3 million in net income.
Historical profitability : The assumptions above are strong. First, the company has recognized that unexpected hardware orders generated extra revenue, which I believe is not sustainable. Second, the company has grown SG&A way above revenues, indicating a lack of cost control.
If we return to historical profitability, the company could generate $2 million in operating income yearly or $1.5 million in net income.
Multiples : DPSI is currently trading at a market cap of $56 million, which implies a P/E ratio of 10.6x under the optimistic scenario and a P/E ratio of 37x under the historical scenario.
The bullish thesis : Although I do not recommend shorting the stock, I also address a more bullish thesis, why the chances for it are slim, and why even if chances were higher, the stock would only be fairly valued, and not really an opportunity.
The recent increase in revenue could signal that DPSI has gained new clients or that existing clients have decided to increase their business level with DPSI.
That level of business would be sustainable if it arose not from a one-time investment decision by a client but rather from a change in internal or external conditions.
An internal change example would be more effective sales efforts, or a new product or service. The company has not mentioned any of these in its MD&A. Particularly, the company does not develop new products, but rather combines products from suppliers into solutions.
An external change could come from a technological improvement that creates a new solution that DPSI can offer its clients (for example when tablets were introduced in the market), a mentality change that makes client more willing to purchase the company's solutions (say the need to digitalize because of the pandemic), or a macroeconomic improvement (more investment because of higher expected business or easier capital conditions). I do not believe none of these elements has developed.
Most important, the weight of evidence is low, or more correctly, short, of only two quarters. Against this relatively slim evidence of a better business, the current share price offers a regular, stable company yield close to 10% (see multiples below).
In my opinion, that is not an asymmetric opportunity: if the optimistic scenario is true (revenues are sustainable), then the investor gets a 10% earnings yield, that today is available from much more stable companies; but if it is not true, then the investor faces a much lower yield and the chance of capital losses (as the multiple adjusts). It seems like tossing a coin with fair chances. I prefer opportunities where chances are skewed towards the investor, the so called 'tails I win, heads I do not lose'.
In the case of DPSI, a multiple that is closer to the historical average earnings would provide that kind of asymmetric opportunity: if business does not improve, the investor gets a regular no-growth 10% yield, but if the business improves, the investor benefits from that growth 'for-free'.
Conclusions
In my opinion, the two multiples offered by DPSI (based on an optimistic and on a historical earnings forecast), are expensive for a company of DPSI characteristics: a competitive industry, lack of growth and profitability, and lack of control over SG&A expenses.
In addition, I do not believe the current profitability levels are sustainable, given that they come from unexpected hardware orders that will not necessarily be repeated in future quarters.
For these reasons, I do not recommend DPSI at these prices. I will reconsider if the company can sustain revenues and profitability levels while containing costs.
For further details see:
Decisionpoint Systems Trades At High Multiples Of Non-Recurring Earnings