It all started a couple of weeks back, when I wrote about how a California judge had granted a summary judgment in favor of Motley Fool Rule Breakers pick Taser
The e-mail I received from that story was predictably passionate. But none were as interesting as the message I received from a reader I can only surmise is a lawyer. He wrote to remind me that the same day Taser was exonerated in California, another wrongful death case appeared in Texas. He went on to say that he would "read Fool.com every day" the next week to see if I covered the story. Well, I did, but probably not in the way he expected. I decided to examine Taser's potential legal liability instead, discovering that the stun-gun maker is reasonably well-protected.
That led to our current question: Given all of its financial and legal issues, is Taser's stock worth the risk? Thirty of you responded, and only one said "no." Some understandably said they'd want the cloud of negative publicity to lift before investing. But most said they believe Taser is the weapon of the future. And that, they wrote, leads them to believe Taser is a buy at current prices. I'll get to whether I think that opinion is justified in a few moments.
A good (and bad) week for London, and for Taser
But I want to start with some good news. Earlier this week, Yasin Hassan Omar, a suspect in the unsuccessful second attempt to bomb London's transportation system, was apprehended with the help of a Taser. I'm personally thankful that local authorities have caught Omar alive and will have the opportunity to question him.
Yet it's worth noting this successful arrest follows the shooting death of an innocent Brazilian man days earlier when he fled from police.
One reader put the contrasting incidents in perspective this way: "If the London police had used a Taser on the innocent Brazilian, as they did on a suspect a few days later, he would still be alive. I am not faulting the police, they are doing an incredible job, but using a Taser could have prevented a tragedy -- which is just what Taser claims."
The $15 million problem that won't go away
Another reader wanted to talk more about Taser's legal exposure. A trial lawyer for 25 years, he said that defending every suit is likely to be a losing strategy:
"First, defense costs will eat Taser alive. It can easily cost $100,000 to get a case ready for summary judgment or trial. Since Taser has a self-insured retention limit of $250,000 (sometimes called a deductible), Taser is paying this expense. This cost is only going to increase in the future as more lawsuits are filed. Taser needs to understand that it is swimming in shark-infested waters, and it costs a lot to swim in that ocean."
Statistics bear this out. A check of the most recent quarterly earnings release shows that Taser's decline in profits almost exactly mirrors its increase in sales, general, and administrative expenses, which management described as costs for "legal services and public education campaigns." The reader went on to write that court losses are all but inevitable:
"If Taser gets hit with a big verdict of around $15 million in just three of the cases, I don't see how [the company] survives.... A big loss at a trial is predictable and inevitable -- considering the number of lawsuits and the quality of some of the plaintiff lawyers."
I'm not about to disagree with an experienced trial lawyer. But another reader pointed out that Taser is getting aggressive in its defense: "[Taser is] requesting that the court award it the cost of attorney's fees from the plaintiff or the opposing attorney for filing a frivolous lawsuit. This, if nothing else, sends the message that there may be something for the opposing attorney to lose."
I find both points compelling. Unfortunately, neither addresses how well Taser's insurance would cover it in the event of one or more negative judgments. So I interviewed Taser President Tom Smith yesterday to find out. Smith says that Taser's insurance doesn't apply per incident; it's cumulative and must be renewed annually. That means the company would be at greatest risk in the event of multiple judgments, especially if those judgments came within the same case year. And it means the doomsday scenario presented above -- three judgments of $15 million or more -- could indeed drive Taser out of business.
Can't you please just say "less lethal?"
Still, I've got my doubts about Taser meeting its end at the hand of lawsuits, partly because of what's going on in Congress. The Senate is debating a bill that would effectively hold gun manufacturers harmless in many wrongful death cases. Taser wouldn't receive any specific benefits if the bill were to become law. But I can imagine lawyers arguing that it creates a standard that would raise the bar for filing future suits against the stun-gun maker.
Moreover, Taser may not be opening itself up to liability in saying that its guns don't kill people. Indeed, Smith says the company switched from describing its products as less lethal to non-lethal to make it easier to sell to government agencies. That's because there is no definition for "less lethal" weapons so far as the Department of Defense goes. But non-lethal, according to this DoD document (in PDF format), refers to weapons that are designed only to "minimize fatalities." In other words: There's no guarantee that you won't die if hit with a non-lethal weapon like a Taser. How that will help the company in court remains to be seen.
Running the numbers
And that takes us back to the big question: Is Taser's stock worth the risk? Last week, I said the minimum we should expect is a triple in three to five years. Unfortunately, that doesn't appear possible if you take a classic valuation approach. Follow along, please.
We'll start by checking Taser's own estimates for the stun-gun market. A 2003 presentation pegged that at 108 million units and more than $43 billion in sales. In our interview, Smith stood by those numbers, which he says represent 100% market penetration. But I think the numbers are a bit outlandish. Instead, let's assume the probable market is 10% of Taser's estimated market size.
Interestingly, Taser has sold only 260,000 units to date, Smith said. That's less than 3% of our revised market estimate of 10.8 million units. With so much headroom available, it's probably reasonable to assume at least 30% to 40% annual sales growth. That allows us to get into specifics.
Conservatively figuring at least 15% sequential sales growth for the remainder of the year -- or half the growth from Q1 to Q2 -- pegs current-year revenue at $56 million. From there we can model two growth scenarios -- one at 30% annually and another at 40% annually -- to arrive at 2009 sales. And conservatively estimating net profit margins of 17.5% and 20% gets us to a set of earnings numbers that we can use to calculate earnings per share (EPS). But first we need to figure shares outstanding.
Let's provide two scenarios here, one more aggressive and one more conservative. The more aggressive approach assumes the rate of shares outstanding will increase 15% for the first three years and 10% thereafter. The conservative model calls for 7% dilution for the first three years and 5% thereafter. Still with me? Good. Now let's look at the results.
My most conservative model, 30% sales growth and 17.5% profit margins, pegged Taser's 2009 net profit at $28 million. My most aggressive estimate, 40% sales growth and 20% profit margins, came in at $43 million.
Under the more aggressive estimate for shares outstanding, I arrived at an EPS range of $0.24 to $0.38. Using the conservative model, I came up with an EPS estimate of between $0.33 and $0.51. Applying a multiple of 30 times earnings -- what I'd consider to be appropriate for such a high-growth stock -- brings a per-share valuation between $7.20 and $15.30. Unfortunately, that's nowhere near a triple, so I won't be buying shares here.
A bullish bottom line?
The good news is that those numbers can't possibly tell the whole story. This is a Rule Breaker we're talking about, after all. It has barely scratched the surface of a multibillion-dollar global market opportunity. Its legal exposure is debatable. And its competition is practically non-existent. (Yeah, I know about StingerSystems (OTC BB: STIY) and Law Enforcement Associates
And management is siding with shareholders. No member of the executive team has sold stock since November, and Phillips Smith, chairman of the board, bought 40,000 shares at $10.70 per stub last month. That's a bullish sign.
Of course, best of all were the comments from those in the line of duty who wrote in to voice their unquestioned support for Taser. I'll give the last word to this officer: "As a police officer for the last 25 years, there is nothing, nor has there ever been, anything that has changed law enforcement the way the TASER has. The number of injuries to officers and suspects has declined dramatically in every department that has implemented the weapons system." Is there anything more important than that? No, I don't think so.
Fool contributor Tim Beyers was glad to see one of the London bombing suspects caught this week. He and his family wish all the residents of that great city -- and the equally devastated residents of Sharm el-Sheik in Egypt -- some well-deserved peace. Tim didn't own stock in any of the companies mentioned in this story at the time of publication. You can find out what is in his portfolio by checking Tim's Fool profile, which is here. The Motley Fool has an ironclad disclosure policy.