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Buy ELBTF on weakness
by James Passin
After watching Microsoft rape one of my core recommendations, I was delighted by the "guilty" verdict in the anti-trust trial. Clinton's craven trial lawyer cronies and insider G-men thugs finally did something to mitigate my pain.
 I downgraded Elbit Ltd. (ELBTF – NASDAQ) from a Strong Buy to Hold after digesting the lowball terms of the Peach Networks divestiture. This downgrade was reported on www.taipanonline.com on March 3, 2000. Since my downgrade, ELBTF has declined 35% to US$10 per share. From its February 2000 peak of US$23, ELBTF is down 53%.
I'm not going to harp on my disgust with ELBTF's strategic decision to hand Peach over to Microsoft (MSFT). In my opinion, a number of factors forced ELBTF's directors" hands. While Peach would have been worth a multiple of its exit price as a public company on NASDAQ, the sale nevertheless highlights the sexiness of ELBTF's bandwidth/wireless portfolio.
The decline in ELBTF's stock price has created an excellent short-term opportunity for buying the stock. At current levels, ELBTF is trading at a 58% discount to Net Asset Value (NAV). The discount is excessive — even given lingering questions regarding the Peach sale. I believe that ELBTF will take concrete actions to realize value in other subsidiaries. As an undervalued play on Israeli telecommunications technology, I recommend ELBTF as a Buy at current levels with a one-year target of US$20 and a three-year target of US$30.
Wireless revolution
Forget Peach. ELBTF's (50% held) Contop subsidiary is the potential blockbuster. Contop has developed a revolutionary technology for converting any cell phone into an electronic wallet. Contop is a leader in a wave of start-ups developing next generation 'mobile commerce" — or M-commerce — solutions. Andersen Consulting projects that M-commerce will be bigger than E-commerce, a trillion dollar industry!
Mainstream investors are focusing on WAP (or Wireless Application Protocol). WAP is a new open standard which converts the languages of the internet (IP, HTML, XML) into a markup language specifically designed for mobile devices. WAP is becoming the de facto global standard for wireless internet.
Most of the competing M-Commerce solutions are based on WAP. Using a wireless internet device, you can make a purchase through your cellphone by accessing an online bank or credit account. While this type of WAP solution is clever, it adds unnecessary layers of complexity.
Contop leverages the existing infrastructure of any cellular network. With Contop's technology, cellular operators don't need WAP to enable M-commerce. On the other hand, Contop can work alongside WAP. Based on its ultra-low cost and broad consumer applications, Contop has tremendous potential for immediate widespread adoption by cellular operators.
Contop's M-commerce technology works by sending short pre-determined messages over cellular networks. The proprietary wireless payment system is initially being applied for vending machines, parking meters and fuel pumps. Using Contop, any cellular operator can become a player in M-commerce — without any massive capital expenditure. Furthermore, Contop allows cellular operators not only to provide a value-added service to customers, but to monetize their entire subscriber base by generating monthly cashflow through Contop purchase financing.
Aggressively building its brand equity, Contop has launched three branded applications: "Cell-F" (gas pumps), "Cell-U-Park" (parking meters), and "Cell-U-Vend" (vending machines). "Cell-F" is pronounced 'self."
If Contop were a private drawing board company, it could bring in venture capital investors based on a US$40-60 million market cap. However, Contop has more than a dozen beta tests around the world with major blue chip customers. And Contop has just announced explosive news: Dor-Alon, one of the largest gas station companies in Israel, is rolling out Cell-F in all of its gas stations in Israel. This is one of the first commercial nationwide M-commerce rollouts in the world. As a stand-alone company on NASDAQ, I believe that Contop would be awarded a valuation similar to Cellpoint (CLPT – NASDAQ), a US$600 million dollar company. This would imply a per share value of US$14 to ELBTF shareholders (pretax, assuming 10% dilution from IPO). The market is currently valuing Contop at zero.
Hard value
Partner (PTNR-NASDAQ) is ELBTF's GSM cellular affiliate. Since I have covered PTNR extensively in previous issues of Taipan, I won't spend much time analyzing the company. PTNR is Israel's third cellular operator. Despite a barrage of bearish forecasts from mainstream analysts, PTNR has been an outstanding success.
Arguably, PTNR was modestly overvalued in the mid-US$20s. However, the subsequent technical correction to the lower teens has rendered PTNR fundamentally undervalued.
 PTNR provides a rock solid support underneath ELBTF's stock price. ELBTF owns 12.4% of PTNR. Since PTNR has 182,000,000 shares outstanding, ELBTF indirectly owns 22.58 million shares, or roughly one share of PTNR for every share of ELBTF. In other words, if PTNR trades at US$12, ELBTF owns US$12 worth of PTNR stock.
Of course, ELBTF would incur a tax liability were it to liquidate its stake in PTNR. ELBTF's cost basis in PTNR is zero (thanks to the brilliant financial engineering of ELBTF management), so ELBTF would theoretically incur the full 35% Israeli tax liability. However, ELBTF management is, in my opinion, smart enough to reduce the tax consequences through an appropriate transaction structure. Furthermore, ELBTF could (in my view) sell its strategic stake in ELTBF to another PTNR affiliate for a significant premium to the market price.
High bandwidth
HyNex (94% held by ELBTF) is an extremely interesting subsidiary. ELBTF recently executed an option to increase its stake to 94%. I believe that I may have been materially undervaluing HyNex in my long-term projections for ELBTF's NAV. As a pure play on high speed "internet infrastructure" with rapidly growing revenues, HyNex could sustain a US$1 billion+ market cap as a standalone company on NASDAQ.
If there's one thing that Chief Technical Officers and telecom gurus tell you about running a telecommunications company (or 'telco"), it's the importance of Quality of Service (QOS). Now, QOS may sound like the motto on a brass plaque awarded to Burger King's employee of the month, but it's actually the holy grail of modern communication networks.
QOS lets telcos monitor the flow of data traffic from end user to end user, allocating available bandwidth and preventing bottlenecks. Without QOS, telcos can't provide next generation services like voice over the internet or video-on-demand. Any high speed network needs QOS to be competitive.
HyNex's current product line offers QOS performance monitoring for ATM networks. ATM (Asynchronous Transfer Mode, not cash machines) is the core architecture for modern communications networks. ATM supports extremely fast and reliable data transmission, enabling cost-effective exchange voice and data transmission (I recommend reviewing HyNex's website: www.hynex.com). I believe that explosive growth of ATM backbones and ATM "overlay networks" will continue — fueling continued growth in demand for HyNex's highly regarded products. HyNex sells its products through OEM agreements with technology giants (hint: look at the KPN ATM network press release in March 1999 ).
I believe that HyNex may be preparing a revolutionary new line of QOS products for IP networks. IP, or "Internet Protocol," represents the cutting edge core "packet switched" architecture of futuristic networks. I don't believe that IP will render ATM obsolete (ATM is clearly superior for voice). However, IP does represent an extremely low cost solution for data-based networks. If HyNex's leadership in the ATM QOS market is any guide, then the imminent launch of IP QOS products could multiply the company's top line growth rate.
In my NAV calculation, I conservatively value HyNex at 5x 2000E sales. However, given the high valuation awarded to similar companies (Cisco has become the most valuable company in the world on the back of router and switch sales), this estimation may be too low. In my opinion, the market is currently assigning almost zero value to HyNex. HyNex's products were recently certified by both MCI-Worldcom and AT&T.
Still stinks
ELBTF's 53% ownership of Elbit Vision Systems (EVSN – NASDAQ) has been a treated as a liability instead of an asset by the market. EVSN is a terribly run company with a fantastic technology. EVSN has a virtual monopoly on the market for optical inspection systems for textile manufacturers. Unfortunately, EVSN has been unable to claw its way back from the Asian crisis — and remains 88% below its 1997 peak.
As a controlling shareholder with a majority stake, ELBTF is required to consolidate sales and earnings from EVSN into own profit/loss account. Since EVSN sales and margins keep collapsing, ELBTF's financial results look terrible from an accounting perspective. However, the quarterly performance of ELBTF primarily reflects non-cash accounting charges consolidated from a separate public company.
It is my view that ELBTF will take concrete action to realize value in EVSN within twelve months. I value the EVSN stake at the market price.
Still the best play on Israeli tech
Thanks to outstanding financial management, ELBTF has US$65 million in cash and zero debt. Other than a large option grant to the CEO, there has been no dilution to shareholders — even though ELBTF is a development stage tech holding company (compare this to the track record of ICGE or CMGI!).
While it is tempting to remain spiteful towards management following the Bill Gates "panty raid" of Peach Networks, you can't build a profitable portfolio on vengeance. ELBTF managers have been punished by a 50% crash in their stock price. I doubt they will make the same mistake twice.
The severe correction in the stock has shaken out weak hands. Given the 1100% gain following my initial 1998 coverage, severe profit taking was inevitable.
In my opinion, it will take approximately 12 months for the market to forgive the lowball Peach divestiture. During the same period, I expect that ELBTF will take concrete corporate actions to realize value in Contop, HyNex, and EVSN. Given ELBTF's robust financial condition, I would expect the company to make a strategic acquisition to expand its overseas marketing channels — and to continue providing seed capital to promising tech start-ups.
Based on the glaring discount to NAV, I am upgrading ELBTF from Hold to Buy with a one-year target of US$20 and three-year target of US$30.
| ELBIT’s ASSETS NOW INCLUDE: |
| Asset |
Stake |
Value (USD) |
Valuation Method |
| PTNR |
12.40% |
$270,000,000 |
Market |
| HyNex |
94% |
$141,000,000 |
5x 2000 sales |
| Contop |
50% |
$35,000,000 |
Not worth more than Peach |
| Cash |
100% |
$65,000,000 |
Balance sheet |
| EVSN |
53% |
$9,000,000 |
Market |
| Real Estate |
100% |
$14,000,000 |
Estimate |
| Misc. |
n/a |
$2,000,000 |
Private estimate |
| Disputed tax |
100% |
($14,000,000) |
Worst case scenario |
| TOTAL |
$522,000,000 |
| PRICE |
$10 |
| NET ASSET VALUE PER SHARE |
$24.31 |
| DISCOUNT |
58% |
James Passin is a Portfolio Manager with Firebird Management and Contributing Editor to Taipan. The views expressed are strickly Mr. Passin's and not necessarily those of Firebird Management or Taipan.
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