Fallen Angel: Sparton Corp.
Recent pressure from an experienced activist investor may kick shares of underperforming Sparton Corp. (NYSE:SPA) into gear.
Jackson, Mich.-based Sparton Corp., a niche electronic design and manufacturing services provider, has lately been feeling the heat. Last month, Lawndale Capital Management, Sparton’s largest independent shareholder, publicly disclosed that it had sent a series of recommendations to the company’s board of directors. These requests included that Sparton appoint four new independent directors, hire a turnaround management team and engage an advisor to explore a potential sale. Lawndale also provided notice of intent to directly nominate these new directors via a proxy contest if its requests were not met. Lawndale has subsequently disclosed that it is having constructive discussions with Sparton’s board over reaching an amicable settlement.
The last few years have not been pretty for Sparton shareholders and clearly the company is in need of changes at the board and management levels. At Monday’s closing price of $3.69 a share, Sparton shares are near their 52-week low of $3.50, set in June, and well off the 52-week high of $6.05 from last October. Going back two years, the stock has declined approximately 50%, during which Sparton has racked up an unenviable track record of eight quarters in a row of operating losses.
Historically, Sparton’s main business was designing and manufacturing sonobuoys, an anti-submarine warfare device, for the U.S. military. While perhaps best known for sonobuoys, Sparton manufacturers a host of niche electronics products for corporate and government markets. In 2005, Sparton opened a manufacturing facility in Vietnam, while in 2006 it further diversified by acquiring Astro Instrumentation, a designer and manufacturer of specialized medical products. For fiscal 2007, Sparton generated 30% of revenue from its medical and scientific operations, 28% from aerospace, 27% from industrial/other and 15% from government. Sparton’s top customers include the U.S. Navy and Honeywell International (NYSE:HON).
Sparton’s diversification efforts have yet to result in sustained profits for its shareholders. For the fiscal third quarter ended March 31, Sparton reported revenue of $58.1 million, a 21.8% annual increase, and an operating loss of $0.42 million. This was a noticeable improvement over the year-ago operating loss of $3.69 million. Sparton’s gross profit margin increased to 7.8% from 1.5%, again an improvement, but a stark reminder of the slim margins that Sparton must tightly manage. Turning to the balance sheet, Sparton ended the quarter with roughly $18 million in net debt outstanding. Sparton believes it has sufficient liquidity for the next year or more.
Back in March, Sparton announced the retirement of long-time president and CEO David Hockenbrocht. The company’s CFO was named interim CEO. Besides the increased public pressure from large shareholder Lawndale, the other major news out of Sparton in recent months was the June announcement that it was closing its New Mexico manufacturing facility. Sparton blamed the closure on the current choppy business climate and increased offshore competition.
Given this string of bad news, why might Sparton represent an intriguing “fallen angel” play at current levels and below? At a recent price of $3.69 a share, Sparton checks in with an enterprise value of $36 million, which values the name at less than 0.3 times last year’s annual revenue of $200 million. Further, based on our estimate, Sparton has a tangible book value of over $6 a share. Given this meager valuation, even with Sparton facing economic headwinds, a much needed Lawndale-led change in corporate governance and an expected jump next year in sonobuoy sales, could lead value investors to take a fresh look at this microcap.
Jackson, Mich.-based Sparton Corp., a niche electronic design and manufacturing services provider, has lately been feeling the heat. Last month, Lawndale Capital Management, Sparton’s largest independent shareholder, publicly disclosed that it had sent a series of recommendations to the company’s board of directors. These requests included that Sparton appoint four new independent directors, hire a turnaround management team and engage an advisor to explore a potential sale. Lawndale also provided notice of intent to directly nominate these new directors via a proxy contest if its requests were not met. Lawndale has subsequently disclosed that it is having constructive discussions with Sparton’s board over reaching an amicable settlement.
The last few years have not been pretty for Sparton shareholders and clearly the company is in need of changes at the board and management levels. At Monday’s closing price of $3.69 a share, Sparton shares are near their 52-week low of $3.50, set in June, and well off the 52-week high of $6.05 from last October. Going back two years, the stock has declined approximately 50%, during which Sparton has racked up an unenviable track record of eight quarters in a row of operating losses.
Historically, Sparton’s main business was designing and manufacturing sonobuoys, an anti-submarine warfare device, for the U.S. military. While perhaps best known for sonobuoys, Sparton manufacturers a host of niche electronics products for corporate and government markets. In 2005, Sparton opened a manufacturing facility in Vietnam, while in 2006 it further diversified by acquiring Astro Instrumentation, a designer and manufacturer of specialized medical products. For fiscal 2007, Sparton generated 30% of revenue from its medical and scientific operations, 28% from aerospace, 27% from industrial/other and 15% from government. Sparton’s top customers include the U.S. Navy and Honeywell International (NYSE:HON).
Sparton’s diversification efforts have yet to result in sustained profits for its shareholders. For the fiscal third quarter ended March 31, Sparton reported revenue of $58.1 million, a 21.8% annual increase, and an operating loss of $0.42 million. This was a noticeable improvement over the year-ago operating loss of $3.69 million. Sparton’s gross profit margin increased to 7.8% from 1.5%, again an improvement, but a stark reminder of the slim margins that Sparton must tightly manage. Turning to the balance sheet, Sparton ended the quarter with roughly $18 million in net debt outstanding. Sparton believes it has sufficient liquidity for the next year or more.
Back in March, Sparton announced the retirement of long-time president and CEO David Hockenbrocht. The company’s CFO was named interim CEO. Besides the increased public pressure from large shareholder Lawndale, the other major news out of Sparton in recent months was the June announcement that it was closing its New Mexico manufacturing facility. Sparton blamed the closure on the current choppy business climate and increased offshore competition.
Given this string of bad news, why might Sparton represent an intriguing “fallen angel” play at current levels and below? At a recent price of $3.69 a share, Sparton checks in with an enterprise value of $36 million, which values the name at less than 0.3 times last year’s annual revenue of $200 million. Further, based on our estimate, Sparton has a tangible book value of over $6 a share. Given this meager valuation, even with Sparton facing economic headwinds, a much needed Lawndale-led change in corporate governance and an expected jump next year in sonobuoy sales, could lead value investors to take a fresh look at this microcap.
About the Author
Contributing author Matt Ragas is an investment writer and analyst with ten years of experience analyzing small and microcap stocks, with a particular emphasis on value and turnaround situations.
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