Thursday, December 11, 1997

Transcrypt International
(Nasdaq: TRII)
Phone: 402-474-4800
Price (12/10/97): $24 1/2


Transcrypt's products help make wireless communications more efficient and secure. The combination of its alliance with Motorola (NYSE: MOT), a major new acquisition, and strong product sales have investors believing it has also secured itself a future in a dynamic marketplace. As a result, the stock has doubled since August.

A 1995 decision by the Federal Communications Commission (FCC) mandated that new land mobile radio (LMR) equipment, the kind used by police and fire departments, must migrate to digital in order to fit more conversations on the bandwidth. This meant that a replacement cycle was on the way as soon as manufacturers could produce digital products to fit the bill.

An association of public safety officials came up with what's known as the APCO 25 open standard. Ericsson and other manufacturers have argued against APCO 25, but supporters such as Motorola seem to have carried the day.

In August 1996, Transcrypt joined Motorola as one of the first companies to introduce a handheld digital LMR that complies with this new standard. It also features the firm's encryption technology. Other secure models, including mobile radios, were introduced this year.

In July, the firm said it would acquire E.F. Johnson, a manufacturer of LMR base stations that had lost $26 million last year on $79 million in sales. After some market uncertainty over the deal, investors now seem convinced that such vertical integration strengthens Transcript, which is now one of the few players that can offer a total APCO 25 digital radio system.

Strong interest in its October secondary offering eased cash concerns. Plus, strong sales helped Transcrypt's net income more than triple in the third quarter. Sales of new LMR systems have begun to pick up, too.


Based in Lincoln, Nebraska, Transcrypt International provides information security and wireless communications products. Its analog scrambling and digital encryption products keep third parties from intercepting voice and data communications. These products have long been marketed to firms such as Motorola as add-ons to land mobile radios.

As the third largest U.S. manufacturer of LMRs, E.F. Johnson significantly expands Transcrypt's wireless communications offerings. Transcrypt's restructuring of Johnson includes shutting down production of low-margin products while introducing a complete line of APCO 25 digital radio products, including hand-held and vehicle-mounted two-way radios, base stations, portables, and other required infrastructure.

The combined company has 800 dealers and distributors in 108 countries. Its products are used by public safety workers, businesses such as fleet operators and taxi companies, government agencies, and even football coaches exchanging play suggestions with colleagues up in the press box.

Competitors include Selectone, Midian Electronics, and MX-COM in the add-on scrambler market and Motorola and Ericsson in the digital encryption market. A number of companies have entered or have announced plans to enter the market for APCO 25 products, including especially Motorola. Insiders now own about 16% of the company.


Income Statement*
12-month sales: $32.3 million
12-month income: $3.85 million
12-month EPS: $0.41
Profit Margin: 11.9%
Market Cap: $317.3 million (Based on 12.95 million shares)
(*Excludes $9.9 million in acquisition-related charges. Includes just two months of E.F. Johnson income.)

Balance Sheet*
Cash: $4.7 million
Current Assets: $47.8 million
Current Liabilities: $39.7 million
Long-term Debt: $5.6 million
(*Excludes $52.6 million raised in the October 27 secondary offering.)

Price-to-earnings: 59.8
Price-to-sales: 9.8*
(*Sales include just two months of E.F. Johnson income)


New mandates from federal agencies often produce Doubles. The FCC's action might have led investors to Transcrypt following its January initial public offering. But the company stumbled out of the blocks, missing earnings estimates by 20% in its first quarter as a public company.

Beginning last summer, though, positive articles started appearing in Investor's Business Daily, Individual Investor, and the Special Situations Report. Analysts were projecting strong sales growth and hefty profits in the digital LMR market.

The acquisition of money-losing E.F. Johnson spooked some investors and presented financial challenges for Transcrypt that the secondary offering has helped resolve. Those who know the industry, though, seem to think the deal is a strong strategic acquisition that will enhance Transcrypt's product offerings, distribution channel, and production capacity.

But since Transcrypt's rise has been driven by investor expectations of rapid growth rather than the current earnings, an investor needed some particular insight into the changing market for the company's products to have found this Double.


First Call shows analyst earnings estimates of $0.56 a share for this year and $0.98 for FY98. The above P/E is a bit misleading given the significant operating losses E.F. Johnson has experienced that aren't figured into trailing earnings. On the other hand, the strong third quarter perhaps justifies using the actual trailing P/E, which would PEG these shares at 0.79 based on the 75% growth projected for next year. YPEG fair value based on projected 27% long-term growth is $26 1/2.

The current price discounts some vibrant earnings over the next five quarters. So any setbacks, such as difficulties digesting E.F. Johnson or delays in new orders, could lead to trouble. On the other hand, Transcrypt looks well positioned to tackle the market for new digital APCO 25 products. Investors competent to analyze that wireless market may want to keep their eyes on this company.

-- Louis Corrigan

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