Monday, June 6, 2011

Calian: Lower Risk Tech

Technology companies are generally more difficult to value than their counterparts in more stable industries. Because of the disruptive nature of change in the tech industry, it's very difficult to forecast earnings a few years out with any degree of certainty. But there are properties a company can possess, even one in the technology industry, that add some certainty to the valuation. A large cash balance is one of them.

Consider Calian Technologies (CTY), a provider of technology products and services for the communications industry. Calian has a cash balance of $25 million against no debt, which results in cash comprising 17% of the company's market cap!

So while the company trades at a price to earnings ratio of 11, it's price to earnings ratio becomes just 9 if the cash is backed out of the company's market cap. The P/E is low despite the high returns on equity the company generates; ROE has been around 20% for many years in a row. Meanwhile, the company paid out $15 million in cash to shareholders last year (in a combination of buybacks and dividends), which is about 10% of the company's market cap.

The cash balance is not the only thing helping stabilize the value of this business, however. The company signs a number of contracts in advance, so much so that it has a backlog of almost $900 million. Compare this to the company's 2010 revenue of just over $200 million.

Furthermore, most of the company's revenue (and a significant portion of profit) comes from supplying labour services (e.g. engineering professionals). This reduces the company's technology risk, as this segment does not have to constantly create a better mousetrap in order to stay competitive.

However, an investment in Calian is not without risk. Almost two thirds of the company's business comes from the Federal Government of Canada. As such, spending cuts or shifts in priorities away from initiatives requiring Calian's services would have a dramatic effect on the company's business and profitability. It's also worth pointing out that the large backlog number is not calculated conservatively, as it includes the value of buyer options, which may or may not be exercised.

To make money over the long-term, investors should seek out companies with high returns on equity with low P/E ratios, as discussed in Joel Greenblatt's book. At Calian's current price, it appears to fit the bill, with a large cash balance as a bonus.

Disclosure: None

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