New Position: Zytronic (ZYT)
Manufacturer of high-performance touchscreens for heavy duty use cases
Buy date : 11th December 2023
Buy price : 82.4p
Although this is a new position to the Fund in December, it is a company I have held before. Back in Feb22 I had bought it 138p, only to sell out in Aug22 at 127p for a small loss. My thesis back then was that they would see a surge of pent-up demand from the gambling industry, as investment into replacement slot machines were put on hold during COVID.
However, the recovery turned out slower than expected, and I exited due to a lack of forward visibility being communicated. Which was the right call, as the shares slid due to the lowered expectations. They did suffered a bombshell of the bankruptcy of one of their key gaming clients.
What they do
Description: A Zytronic touchscreen used in a phone kiosk. Image source : Zytronic LinkedIn page
The elevator pitch is that Zytronic are masters of making complex and large touchscreens, for heavy duty commercial use cases. Think the screens for slot machines in casinos, massive touchscreens for vending machines, or interactive screen tables for museums. They distribute their products globally, and their clients are device makers (so Zytronic are only supplying one component usually - the touchscreen).
Why buy now
When I had my regular relook at Zytronic at the start of Dec, I realised it now ticked all four of my investment criteria. It was definitely under the radar - very little chat in any of the investor forums, investing publications. Obviously poor sentiment, given the lacklustre and disappointing results and updates.
The results for the half year ending Sep23 were always going to be terrible - continued impact of their large client bankruptcy, overstocking issues, etc. And the trading update on the 18th Dec confirmed so. Interestingly, despite a decrease in HYoHY revenues, they were profitable (pre-exceptional) in the second half, improving from a loss in the first half.
The catalyst for growth and operational leverage - I think we’re about to turn the corner on this one. Despite the poor revenues in CY2023, the company has grown their order books. Now, I take that pipeline1 with some scepticism - 491 pipeline opportunities, £62m of potential lifetime project value? For a company with £8.6m revenues in FY23? However, the more interesting this is the growth of the number of opportunities, and the sizing since the year before. The consistent story from management is that their projects have a long lead time - touchscreen design, software, manufacturing, etc - something in the region of 18-24 months. Initial lead generation was hampered by COVID through travel restrictions. So sales really only started going again in Q1-22. We’re now in Q1-24, which is 24 months, and so if management have been honest, we should start to see an unwinding of that large Pipeline into a firm order book.
The market cap currently (c£8m) is only implying a 1x multiple on depressed FY23 revenue. I am unsure what sort of margins they can get these days (maybe the competition has heated up), but pre-2019 they were getting double digit operating margins. I reckon if they can demonstrate, medium-term, a 10% operating margin, and revenue growth rates of at least 20%, we could get a P/S multiple of like 2.5x easily. I think it could be feasible they are able to get to £12m revenue forecast for FY25, and so a potential 295p share price from the current 80p.
Finally, the last investment criteria - solid balance sheet to execute the turnaround. With £4.7m net cash (FY Sep23) and what was over 135p NTAV (as of Mar23), there’s enough there to support the working capital requirements of getting growth back up. I think there is little risk here of them doing an equity fundraising, despite the trading struggle they have gone through.
The Bear Case
The other side of the story? Well, there is still no positive commentary from management. Latest TU had nothing on upcoming outlook, although they are releasing HY Sep23 results in the first half of Jan, so maybe they were holding back updates till then.
Management is stale - CEO, CFO have been in the company for ages, even when they were not doing well pre-COVID. Why would they be a good catalyst for change? The bright spots are that the Chairman (Chris Potts) is new having joined Aug23. Also, one of the largest shareholders, John Walter, joined the board in Feb23. So here’s hoping they have injected some freshness in strategy and direction and urgency.
Conclusion
I was burnt by Zytronic once before, will I be burnt again? Do I have rose tinted glasses that stubbornly refuse to give up on this company? My view is that sentiment here is so bad that none of the opportunity has been priced in. Considering that their CRM pipeline has gone up about 80% from Nov21 to Mar23, and most of that is going to start translating to revenue in 2024 (assuming the pipeline is real). I don’t think they have enough to get back to pre-COVID revenues of £20m+ a year, at least not by 2026. But I can see a scenario where they can easily get to £12m, if not around £15m. On that basis, I’m happy to hold, given the downside is limited and potentially a 2x upside.
It was also interesting that despite a lacklustre trading update in mid-Dec, the share price action was zero. This supports the theory that sentiment here is potentially rock-bottom, and all the bad news is more than priced in.
We will find out more in the HY results soon to be announced!
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CRM Pipeline numbers as of Mar23
Hello Boon, Mark (Illiswilgig) here. I've just headed over from Stockopedia. Great idea to open a substack - I may have to investigate doing the same. I intended to read your 2023 summary then I noticed this article. Very interested to see that you have bought back into ZYT. I still hold.
Generally I agree with you. Out of favour - Neglected - Big potential opportunity - Low cost base - Operational Leverage and Piles of Cash to execute. But will it succeed? Is always the question. I have a hard time making up my mind. I don't think its fair to lay the blame for global overstocking and the chapter 11 proceedings of a customer (I see Quixant, now Nexteq also took a $0.9m write off for probably the same customer) on management. But I'm equally unsure what they are planning to do differently to turn things around?
I rate the management, CEO, FD and TD, and feel the company is well managed, finances conservative and production facilities and processes first rate. I feel that there may have been a gap in the business development, sales, order process chain. Which has led to mediocre orders from a big potential opportunity pipeline. Not an easy thing to fix as its not under ZYT control which products that they succeed in getting designed into then go on to blockbusters? I expect that the business development & sales process is probably where the new CEO and NED (who is the largest shareholder) are putting their effort. I'm looking for signs that its going to pay off?
I had been hoping the price would fall a little further for me to top up at a bargain basement level. Like you I've been interested that its refused to sink any further after the update. I don't see much if any downside from here. Perhaps its already at the bargain basement?
Thanks for posting this - and cheers,
Mark