Applied Signal's Price Is Just Not Right (APSG.DL)

Applied Signal's Price Is Just Not Right

By Chris Jones | More Articles
December 23, 2008 | Comments (2)

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Those under the influence of Orwellian satire might choose to believe that Applied Signal (Nasdaq: APSG ) is merely an instrument of totalitarian regimes used to control their populaces. Granted, it was founded in 1984, but it's more likely that Applied's products go toward preventing catastrophes and making the world more secure for civilians and those serving in the armed forces.

This small-cap defense outfit supplies the military and intelligence communities with the technology they need to remain, well, intelligent. Its products have applications ranging from communications and weapons systems detection to location of hidden explosives. It recently finished its fiscal 2008 with record high revenues, which potentially makes it a beacon of hope amid an economy in the dark. But is it enough?

When it announced its fourth-quarter and fiscal 2008 financial results last week, the public learned that Applied's yearly sales were a record $186.3 million -- up 9.4% from 2007. Operating margin, a measure of management's efficiency, hardly budged from last year, though earnings per share increased 14.5% to $0.63. More interestingly, it added 100 people to its staff, and announced intentions to add more in fiscal 2009.

Furthermore, management said that over the next several years, the government will need to upgrade existing signals intelligence equipment with new technology, which would provide Applied with an intravenous drip of taxpayer money.

Foolish takeaway
On the whole, it was a promising report of financial results, and there are plenty of good things to say on Applied's behalf. It's a slow and steady revenue grower that sports a 3% dividend yield. It differentiates itself from competitors like Argon ST (Nasdaq: STST ) and L-3 Communications (NYSE: LLL ) by focusing on providing superior value and customer service. I've always believed that the bitterness created by poor quality and service lingers long after the sweetness of low price is forgotten, so I was practically sold.

Then I saw it. Within an arm's reach of its 52-week high, its shares were trading more than 26 times its trailing earnings per share. Thanks, but no thanks. I've got nothing but love for Applied, but I must respectfully decline it an invite into my portfolio -- for now. Things could change down the road, so it's going on my watch list while I keep hunting.

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Chris Jones does not own shares in any of the companies mentioned. The Motley Fool's disclosure policy reads like a Robert Ludlum novel.

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Report this Comment On December 23, 2008, at 4:30 PM, joejim39 wrote:

You shouldn't value APSG on P/E...cash earnings is more meaningful...also, you have to consider the almost $60 million in cash they have on their balance sheet in your valuation. Stock-based comp is going to decline meaningfully in 2009 (cost them about $0.29/share in 2008). Given their cash the stock is really selling near $12-$13/share...add back the stock based comp that is going away and you have closer to $0.90/share for normalized earnings...not so expensive now is it? Not to mention you have a company that is actually growing earnings in the current environment with zero credit risk (they sell to govt and have more cash than they know what to do with)...name me another company that has that going for them in this economy??? Disclosure...I'm long APSG.
Report this Comment On January 09, 2009, at 12:16 PM, MrSIGINT wrote:

I'm a little surprised at APSG's run up in price but I know what I'm doing...shorting! Why? Well, you need to know a little about APSG's business and especially their mercurial customers. I've been in the signals intelligence business for over 20 years and I know APSG well...very well. I also know their key customers and how APSG equipment/services is perceived by them.
Here's the scoop: APSG could be a few steps away from a sales cliff. Look, only $11M of their revenue comes from selling products that you see on their website or in their catalog. The rest is custom development and services. Of the rest ($175M), 40% of that number is with one, yes one customer in a three letter intelligence agency that will remain unnamed. This customer is under enormous pressure to eliminate "proprietary solutions"--which APSG equipment is considered--and move to a common flexible signal processing platform that this agency has invested billions in developing and is being touted as the corporate solution. You may hear this solution referred to as the "TU" solution which is shorthand for its codename. Further, the key champions of APSG within the singular customer are retiring, or moving on. Without these advocates/champions and with the pressures to conform to the TU solution, APSG is in a very, very vulnerable position to lose a good chunk of that 40% in specialized hardware and development services. Ouch!
Then there is the "other" three letter agency customer. APSG has gotten fat off of a regular series of deployments of specialized signals collection equipment that they sell to this customer. Well, due to some global political issues and what can best be referred to as "access issues," this customer does not have foreseeable deployments on their schedule. In fact, nearly half of the equipment APSG develops for this customer never sees the light of day. They're just glorified science projects that some govvie managed to scare up some money for. This lack of deployments can easily have a $10-20M shortfall impact on the company.
Then there is the wireless side of the business. Although APSG has been pumping out a series of press releases, much of it is untested and unproven. APSG ranks a distant third in the wireless field behind DRT and ARGON ST. A lot has to do with their costs. APSG is typically off the charts compared with their competitors. A lot of that has to do with their location in Sunnyvale and their overhead. They have way too much office space...even a shipping clerk is given their own office! Right in the epicenter of Silicon Valley! It's nuts and a huge impact on their costs.
Perhaps the new leadership can get the costs under control, but there are a lot of sacred cows at APSG and "old-timers" that will be highly resistive of any changes. Time will tell, but I'm more concerned about the real possibility of a $20-40M shortfall in FY 2009 for the reasons I idenfied earlier.
And Democrats have not been kind on the intelligence agencies...we'll leave that for another discuussion.