Warning: The following article is for informational purposes only and should not be considered as investment advice. The author is not a registered financial advisor and does not provide investment recommendations. Any investment decisions you make should be based on your own research and analysis.
Additionally, please be aware that the author may have a financial interest in the securities discussed in this article. The author reserves the right to buy or sell any security mentioned in this article at any time, without prior notice. Therefore, the information presented in this article should not be considered as a solicitation to buy or sell any security. Please consult with a registered financial advisor before making any investment decisions.
Overview
In what is apparently becoming a theme, this week we’ll again discuss a marine-centric special situation opportunity. With a market cap smaller than some small businesses down the block from me would be sold for, MIND Technology is a fascinating tiny company, with a litany of issues, but huge potential. As I’m sure you guessed, it's not the huge potential that interests me, but rather the litany of issues. Formerly Mitcham Industries, the current iteration of MIND Technology sells deep sea sonar and seismic scanning products into various end markets including mining, drilling, and defense. Over the next several years I believe all of these end markets offer major potential for the company, though this is not why I like it from an investment perspective. Rather than capture the potential upside MIND presents as a picks and shovels play in these end markets through the common stock, I believe its various issues provide a great opportunity in the company’s preferred shares.
The Set Up
For most people the phrase “supply chain issues” is one that if they never heard again it would be too soon (myself included). Unfortunately it's unavoidable in the case of MIND, as it has become the bane of the company’s existence. Despite having a robust backlog, the company is unable to deliver its products because of these issues. This has made the liquidity situation tight to say the least. On the back of this, the company has suspended paying the dividend on its preferred shares, instead opting to make investments in the business. This is where the opportunity comes in. The dividend attached to the preferred stock is not like that of a normal common stock, where missed or canceled payments are simply missed or canceled payments. Instead, these missed payments build up as deferred payments to be paid out to holders at a later date (to clarify for those unfamiliar: the terms we discuss are specific to MIND and will vary in other situations). This means that the unpaid dividends on the preferred are accumulating into cash payments that will be paid out as a windfall at some point in the future. Currently this is sitting at five quarters worth of dividends. So the question becomes, “If the company hasn’t paid these dividends then why will they start doing so now?” The answer is two fold. First, is the mechanics of the preferred shares themselves. If the company does not pay out a dividend on the preferred shares for six quarters the preferred shareholders can elect two members to the Board of Directors - something management has made clear they want to avoid. The company does not need to pay the whole thing at once, as the clause only takes effect if there are six quarters of deferrals built up, but with the number now hitting five, management will prioritize starting to make these payments by any means possible. Second is an inflection in the business itself. The company has now gone adjusted EBITDA positive (gross, I know) for two straight quarters, and has achieved a positive working capital position. The combination of these factors makes it highly likely that the company starts to pay the dividend at its next payment period in October.
Valuation
This is not the first time I’ve said this (or even the second), but this will almost definitely be the shortest valuation section I ever write. Par on the preferred shares is $25 with a 9% dividend equaling a $2.25 annual pay out. As we discussed, the shares also have five quarters of deferred dividends, equating to about another $2.81. Adding this $2.81 into the eventual reversion to the $25 par that should come with these payments, comes out to a package totaling $27.81 - more than a 3.7x gain from the current price of $7.49. On top of this, you have the $2.25 that will be paid out annually as dividends going forward, about a 30% yield at current levels. Not a bad payment while you wait for the larger upside. Lastly, by holding the preferred shares for the longer term you can clip off a very safe and respectable 9% coupon as a terminal value.
Summary
While not quite an exciting play on deep sea technology, the MIND preferred shares offer a very compelling opportunity. Despite your upside being capped, MIND preferreds offer the potential to realize a large amount of value in a relatively quick period of time without taking on a significant amount of risk - you could certainly do worse.
You cook the kind of food that I like man. How do you keep sourcing interesting ideas like these? Any plans to switch to a paid subscription anytime soon?
My feeling is that the company is just going to pay one dividend to avoid the triggers and then halt them again to save capital
Nothing stops them from doing this
Do you agree ?