Expected Value vs. $1.42 Market Price (as of 9/11/19) = $2.85/share
101% Upside To PEYE’s Price Target, Which Reflects a P/S Multiple of 3.7X
Comparable Companies Trade at an Average 5.7X Revenue Multiple, Versus Just 1.7X for PEYE
Precision Optics Corporation (ticker PEYE) is a microcap medical device company whose products include microprecision lenses and micro medical camera, 3D endoscope, and robotic surgery systems. Over the past five years, PEYE has basically been treading water, with annual losses ranging from $350,000 to $1.2 million and annual revenues relatively flat in the $3 million to $4 million range. However, PEYE recently completed the acquisition of Ross Optical Industries, Inc., which appears to significantly improve PEYE’s investment risk-reward calculus. On a pro forma basis giving effect to the transaction, PEYE was solidly profitable in FY 2018 and basically breakeven in the first three quarters of FY 2019. Moreover, the Ross transaction will cost PEYE shareholders just $2 million at most, pending a $500,000 contingent earnout payment, meaning PEYE acquired Ross at just a mid-single digit P/E multiple, a seeming bargain.
Acquisitions can really move the needle for an acquirer’s investors, occasionally for the better, unfortunately more often for the worse (normally acquisitions are value destructive because they are made primarily for management’s empire building purposes). Happily, however, in PEYE’s case we think the Ross acquisition falls clearly in the former category. With high insider ownership (major shareholders hold around 45% of the outstanding common stock), one can expect the merged company’s assets to be put to their highest and best use, with the benefits thereof accruing to the company’s owners (PEYE longs). Given a recent stock price of $1.42/share, there is ample 101% upside for shareholders to our target price of $2.85/share (or ~3.7X our pro forma FY 2019 revenue estimate). This multiple appears more than reasonable given the combined company’s nearly 25% organic revenue growth and near breakeven underlying operations. (For comparison purposes, peers in the medical device space trade at an average revenue multiple of 5.7X.) In sum, with the Ross Acquisition, PEYE’s pie just got quite a bit large for shareholders, but with minimal dilution. Enterprising small and micro-cap investors should carve a slice out for their portfolios.