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I don't make this stuff up. I'm not that smart.

Archive for May 2010

Visual Heads-Up Computer Navigation and Simulations Plus (SLP)

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On April 17, I wrote about using sensitivity analysis and enterprise Enterprise Discounted Cash Flow (eDCF) analysis to identify intrinsic value for any given stock — http://caps.fool.com/Blogs/ViewPost.aspx?bpid=378650&t=01004821517556035447, with the actual description (along with charts and graphs demonstrating the concept) at my personal blog https://rcrawford.wordpress.com/2010/04/17/sensitivity-analysis-for-simulations-plus/ .

As with any presentation of a concept, it is typically necessary to use an example or two, and, in this case, I used Simulations Plus (SLP). Interestingly, I used SLP (a software company whose principal product calculates/predicts the metabolic effectiveness of potential medications in the human body prior to human trials) because the company is so small that is not covered by The MotleyFool. This is, after all, a $35 million company – selling at $2.11 a share. Moreover, last year the stock was selling at just above its delisting price of one dollar (which is roughly where I purchased it). Candidly, I used SLP as the example because the article was written to describe a largely unrecognized approach to valuing stocks, and I didn’t want readers to wrongly conclude that I was advocating its purchase.

That changed yesterday, when the company announced a new product offering – software that will allow the computer user to navigate visually, without a mouse.

Now this may seem like a nifty idea whose time has come (perhaps, even, one that is long overdue) but nothing ground shaking, and that is how I viewed it, as well. I was, however, intrigued enough to consider the changes likely to arrive with the company’s strategic posture and customer demand. As described on a different discussion board, here are my conclusions:

I’m always leery about writing glowing comments about a stock I own, since doing so is so blatantly self-serving, but, in this case, I suspect the news is being underplayed and underappreciated. While I would like to have more information about pricing of the new product, customer demand should be significant. I just looked up the figures for quadriplegia, for example. There are 5000 new quadriplegics for whom this product would be a benefit each year, with a further 1000 in the UK. Add to this the other first world countries (including nearby Canada), and you begin to have a grasp of the degree of potential customer demand. Quadriplegia, of course, is not the only diagnosis for which this product would represent a significant benefit to customers. The lifetime risk of developing carpal tunnel syndrome is 10% of the adult population. Add to this the sports injuries which effect arms and hands for, either, an extended period or as persistent/chronic conditions, and this number grows even further. Moreover, think about the extent to which computers represent viable employment options for those suffering from any of these conditions, the support requirements for afflicted workers under OSHA, and the degree to which computer use at home now represents a communications and information necessity, and the question of consumer demand becomes all the more clear.

This, however, represents just the first layer of consideration. As an early entrant, the company will enjoy significant strategic benefits based on the production model described in the announcement article (i.e., outsourcing production) — http://finance.yahoo.com/news/SLP-Subsidiary-Words-Launches-bw-56839333.html?x=0&.v=1. Specifically, if marketed aggressively, it will be easy to acquire significant share of mind in much the same way as Dragon Dictate with voice recognition software. Strategically, this model provides defensive benefits, as well. Based on contractual production, the company will have a clear picture of stepwise unit margins and various production volumes sufficient to defend the space with product positioning and pricing. There is, as well, the barrier to entry associated with research and development – which the company has already expensed. While it will be necessary to maintain the developmental edge, the upfront costs of initial product development are already accounted for in prior financial statements. In other words, the company has already paid to create the product. As sales increase, economies of scale and defensible margins should more prominently materialize, to the benefit of stockholders, customers, and, most pleasantly, society at large.

I may be wrong, but this strikes me as game changing in a way that Word+ (another SLP product) was not (in my view). If true (i.e., this is, in fact, game changing), earlier estimates of this being a $4-$5 stock seem conservative. At minimum, this product addition makes the $4-$5 range less speculative and, all else being equal, makes it more reliable due to cash flow expansion. Even if profit margins remaine stable at around 19%, the increased volume in sales and the resultant growth seem likely to expand return on assets prior to any consideration of the equity multiplier associated with return on equity.

Of course, others may see this differently, and I would be interested in reading the contrarian perspective. At this point, however, I do not see how this can be remotely perceived as a negative for the company, the stock, or consumers.

Written by rcrawford

May 12, 2010 at 4:28 am

Posted in Investments

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