Logic Instrument: melting ice-cube net net with corporate governance issues
I’m going to pass on Logic Instrument: (ALLOG.PA). It looked attractive on initial inspection due to being a net current asset value (NCAV) net-net, but after looking more closely showed several warning signs.
Starting with the positive:
The business operates in France and Germany, to produce ruggedised versions of electronic devices, such as laptops, smartphones etc., which are manufactured in China and Taiwan.
Valuation: the company has as of Jun-21, €4.9M cash & equivalents, and a €4.7M net current asset values (current assets- total liabilities), vs a market cap of €3.7M: so there is a €1M margin of safety, or 24%. About €1.2M of current assets are inventory.
Low cash burn: starting 2016, after the company was restructured (reduced from 26 employees to 16 in 2015), it has had two profitable years and three loss making years, with a total net loss of €0.56M in 2016-2020 inclusive.
Negatives:
Control by, and relationship with, ARCHOS S.A. 25% of Logic’s shares are owned by ARCHOS S.A (ALJXR.PA), but ARCHOS controls Logic Instrument completely and consolidates it in its accounts, according to the ARCHOS 2021 AGM report. This is due ARCHOS subscribing to a 2014 capital increase of Logic Instrument (due to losses at the time), and in return for the rescue Logic Instrument surrendered it’s independence to ARCHOS. The two companies are closely intertwined: this is explained more below.
Regulated agreements between Logic Instrument and ARCHOS:
There are three agreements between Logic Instruments and ARCHOS, from the special auditor report on this, which can be found on the Logic Instrument website here.
AgreementTerms (commission rates)Cost to Logic Instrument to ARCHOS in FY 2020ServicesCost plus 5%€244kPurchasesCost plus 4% (ARCHOS branded)
Cost plus 3% (non-ARCHOS branded)€75kContracts 2% commission on all contracts€54kTotal€374k
The total of €374k is more than the loss than Logic Instrument made of €215k in 2020. The potential conflict of interest is between Logic Instrument shareholders, who wish to minimise payments to ARCHOS, and the common management of Logic and ARCHOS, who may have different incentives. The setting of costs is also not transparent, and adding to this concern is the poor financial state of ARCHOS, which has done a number of bond and warrant issues, and continues to be loss-making. The figures in the table above indicate that Logic Instrument buys a significant proportion of its goods through ARCHOS.
Working capital requirements
Due to the Covid pandemic, the turnover of Logic Instrument decreased substantially in 2020, and so €1.6M of working capital was freed up. However, in 2021 H1, with 40% lower turnover than H1 2020, Logic made a loss of €0.5M. In order to return to break even/profit, turnover will need to increase substantially, so I expect most if not all of the working capital reduction to be reversed. This is greater than the margin of safety. If it is not reversed, the margin of safety in cash will be consumed anyway in 1 year through operating losses – so either way: there is no durable margin of safety.
EMP Loan from the French Government: The French government provided a loan of €1.2M to Logic Instrument in 2020, as part of their support for businesses during the Covid pandemic, which will have to be repaid over the next five years: although it is interest free for 12 months.
Share issues: Before the restructuring in 2015, there were large losses and the share count increased from 1.5M shares out in 2012, to the current total of 8.6M shares out in 2017. If there are significant losses again, it is likely that the management will have no option but to further dilute shareholders. In addition, in 2021 the company recently carried out a share capital reduction, reducing the par value of its shares from €0.50 to €0.01, stating in its 2021 AGM report that the reason was to, ‘remove an obstacle to the issuance of new shares,’ (original report is in French, was translated using a machine translation service), therefore indicating that this is likely to happen.
Business quality: This appears to be a low quality business because: the inventory rapidly depreciates in value as it is electronic devices: overall in the last 9 years since 2012 the company made a significant loss of net €4.3M, revenues have decreased by 17% in this period, and making ruggedised versions of electronic devices is likely to be a business that it is difficult to differentiate from competitors in, evidenced by the gross margin on ~30% in 2020.
Conclusions on Logic Instrument
Logic Instrument is a net net, but only because its turnover has shrunk significantly due to the Covid pandemic, and now it is losing money and rapidly eroding its margin of safety. If its turnover increases, the current margin of safety will be eaten up by increases in working capital required.
The ownership and control structure with ARCHOS gives rise to potential conflicts of interest, between Logic Instrument shareholders, and the management, which manage both ARCHOS and Logic Instruments. This can be seen by examining the regulated agreements between the companies.
I will pass on this stock; either reason would be sufficient.
Disclosure: I do not hold any position in Logic Instrument or ARCHOS S.A., long or short.
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