In January ENWV bought back all the preferred shares from Oak Investments for $36 million. This was discounted from Oak’s original Investment by $9 million. This was a huge step in the right direction for shareholders for two reasons. First, it took the slightly submerged overhang of the preferred shares off the books, and at a discount. But more importantly the company is not beholden to Oak any more. This frees the company to be acquired by another company. That is not a prediction. But another company did not really have the option prior to the buy out of the preferred shares.

Since then, a whole lot interest has been paid to ENWV. On 2/8/10 Dimensional Advisors disclosed a 7.8% position in the company. On 2/10/10 Portolan Investment disclosed a 4.3% position in the company. On 2/16/10 Potomac Capital disclosed a 6.19% position. Empire has also increased its holdings, although some of that may have been a year end loss, and repurchase after 30 days. In any case, if you are the type of investor that likes to see other investors buying, then you would like this news. I am only interested in what investors I respect are doing, or company officers. Nothing in the 13G/A’s to indicate management is interested in their own stock.

I estimate their current NCAV value at $3.19- $3.52, depending on how you calculate it. Taking the Graham Margin of Safety of 33% gives you a purchase price somewhere around $2.32 on the high side. The shares closed yesterday at $2.60/share. But if you are willing to take a smaller margin of safety you might be interested. But I would caution you as always to think twice before making any investment. Do your own research. Double check everything. Since ENWV is still losing money on operations of $3.4 million per quarter, as reported in their latest 8k, ENWV still seems like a risky proposition to me.

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Please note this is a lot longer post than usual, so if you have a short attention span, wait until tomorrow.

I first learned about Endwave a couple of months ago from the GuruFocus NCAV newsletter which I have posted about previously.  It looked very exciting. It was trading at around $2.50/share when I first noticed it. And ultimately, if you like the ENWV it has fallen in price since then, to close yesterday at $2.36.  Gurufocus estimated the Net Net value was $5.65. Wow, what an upside, I thought. I evaluated the company strictly from their financial reports and came up with an intrinsic value of $5.51. But given how few spectacular deals I see around right now, I definitely thought ENWV needed a more thorough investigation. Something didn’t smell right.

In their 10k Endwave says of themselves that they “design, manufacture and market radio frequency, or RF, modules that enable the transmission, reception and processing of high frequency signals. Our target markets include telecommunication networks, defense electronics, homeland security systems, electronic instrumentation and other applications that require high frequency RF circuitry and subsystems. ” O.k., so there business is out of my expertise. Again, if the margin of error is big enough I will make an exception to this rule.

In a nod to Philip A Fisher I started with a little scuttlebutt work. And the thing I learned right away is that ENWV’s management has some very dissatisfied investors. This is the complete contrast to Solitron Devices, whose investors by and large seem to be happy with management despite the low share price. This post from seeyanever on the Yahoo forum in September:

“Ed (Keible, then CEO) announces first Q revs of 12 million in April. At this time he tells us he has sold the D&S business to help position the Co. for further growth.

Ed announces second Q revs of 5 million in July and tells us the Co. is going to reprice options for all employees and managers from any price above $5 down to current price $2.35 in order to MOTIVATE them to do a good job. Gives guidance of 4 million in order to set the bar low enough to meet expectations.

Ed tells us in Sept ( after option repricing ) that the Co. now thinks revs for Q3 will really be 2.5 million.

In my world this would get you FIRED. In Ed’s world this gets you promoted.

WTF…………….”

This post brings up two issues that are worth noting. First is management compensation. With my recent VaxGen experience, I have become hyper attentive to management, particularly how they can effect the down side. As I posted yesterday, management is important, not just that they are ethical, but that their interests in line with shareholders. So when you see Management enriching themselves while stockholders are suffering, management is clearly flipping the bird to investors.

In another yahoo forum posting from playon5984 (his caps not mine. I told you they were not happy), “HERE IS WHAT THE EXECS AT THIS COMPANY MAKE WHEN SALES THIS QUARTER ARE $2.5 MILLION. ED’S SALARY PRORATED IS ABOUT 225K THIS QUARTER PLUS BENEFITS. SO 10% OF COMPANY SALES (THAT IS SALES NOT PROFITS) GOES TO PAY ED’S SALARY THIS QUARTER! ” I could go on. Reducing option prices for management as the stock price plummets and revenues jump off a cliff can in no way be construed as stockholder friendly. At the end of October Endwave issued an 8k announcing that Mr Keible would be stepping down from the position of CEO, but would entitled to a full severance package. He was replaced by John Mikulsky as president and chief executive officer. Mr. Mikulsky was previously the COO. In fact as of today the Endwave website still lists Keible as CEO, so this is in effect no change in the course of management and not a cause for celebration shareholders.

But, enough said on the management front. This was enough for me to opt out. The clear management approach has been to enrich themselves at shareholder expense without much, or any plan for achieving profitability or growing the company.

But I continued to search. With a company that is this beaten down it would not take much good news for their to be big swing to the positive. With a big enough margin of safety even a clown could extract some value for shareholders.

That brings us to other point from seeyanever‘s post. In April 2009 Endwave” sold its defense and security business to Microsemi Corporation (“Microsemi”)” for $28 million in cash. The question is what does that leave left? According to their latest 10Q “Subsequent to the divesture (sic) of our defense and security business, we depend on the mobile communication industry for substantially all of our revenues.” Moreover ENWV further discloses that all their eggs are essentially in a basket of three companies, “For the three months ended September 30, 2009, Nokia Siemens Networks and its manufacturing partner, SRI Radio Systems, Nera and Flextronics accounted for 42%, 35% and 14%, respectively, of the Company’s total revenues.”

What is Endwave’s plan moving forward. Again from their latest 10Q “One of our strategies is to grow through acquisitions. To that end, we have completed six acquisitions since our initial public offering in October 2000. We intend to continue to pursue acquisitions in our markets that we believe will be beneficial to our business.” The problem is that since they sold the division responsible for the bulk of revenues they have had eight months and made no acquisitions or present a clearly focused plan. I am not a fan of growing a company exclusively through acquisitions, which it seems Endwave’s strategy is based on. I think it is often costly and is unlikely to add shareholder value. But it does make management look busy.

Let’s turn to Endwave’s financials. According to their latest 10Q 3rd Quarter revenue was $3.1 which was a drop of 45% from the previous quarters income of $5.6 million and a 70% drop from their year over year 3rd Quarter revenue. Meanwhile their losses are skyrocketing.  Operating losses in Trailing Twelve Months (TTM) are $22.1 million compared to $16.1 million for 2008. Given that the trend is still toward the negative, one cannot expect them to remain a Net Net company long, particularly if they do make an acquisition.

Finally, let’s turn to the issue of the Preferred shares that were purchased by Oak Investment Partners XI. They purchased 90,000 preferred shares and warrants to purchase additional shares, which have since expired, for $45 million.  These are unusual preferred shares and from a Net Net valuation perspective, and  ultimately, diluting to common shareholders. Oak has the right to convert to common shares at any time at a ratio of 10 common share per preferred share at an exercise price of $15/share. Preferred shareholders get to vote as if their stock had been converted to common stock and get a seat on the board of directors. No problems so far. In the event of “Liquidation (as hereinafter defined), prior to and in preference to other classes or series of Endwave’s capital stock, the amount initially invested plus all accumulated or accrued and unpaid dividends.” According to the original 8k from 2006, this also includes “a merger, reorganization or consolidation.” Thus in a worse case scenario one must deduct the $45 million that Oak invested from the Assets to arrive at a true Net net calculation. Once done Endwave’s true Net Current Asset value is approx. $2.56/share. This is no longer the thumper deal it originally seemed. It doesn’t even qualify as an investible Net Net with the 33% discount off Net Net Value. This is also a lesson in why it is essential to read the actual SEC documents and not just go by the financial statements. Yes it takes more time. But the difference in this case is Enormous.

Looking forward, not only is future dim, but it seems the cash burn will extend into the future as far as the eye can see. Moreover ENWV has nothing in place that looks like it can turn the company around.

But here is the only important question. Does any of that matter? That I leave to you. I have already said I did not invest in Endwave. That doesn’t mean I won’t in the future. But something needs to change before I will.

Please note that I have posted an update to this analysis. Please check it out ENWV an update.

Disclaimer: As usual, please don’t be an idiot and make investment decisions based on what someone writes on the internet, even me. Even if you think it is genius. Even if you agree with me, please do your own research. Like anyone else, anything I write is subject to human error. This is an educational website and not meant as investment advice in the legally binding sense of the word. I am, after all, a part time investor working in the film business.

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