CDW Holding Limited

I invested in CDW Holding in March 2015, with an initial investment of 400,000 shares at around $0.18. Since then, the company has distributed generous dividends of 1.2 US cents annually. Which is a nice yield of around 9% or so.

CDW Holding is in the business of manufacturing light guide panels which are used mainly in smartphones, laptops and notebook computers. It also has a smaller division manufacturing precision parts for office equipment and electrical appliances. Most recently, it branched out into F&B, acquiring a ramen business in Japan.

CDW is what I’d describe as a “unique situation” investment – these are defined by me as situations where the valuation may not be the absolute key. Rather, the key to whether the investment is successful in the short to mid term depends on a certain factor or catalyst.

Earnings

Here is CDW’s multi year income statement:

The earnings are “diluted” as there are currently 19,000,000 share options awarded as part of employee remuneration, and these are mostly “in the money” and likely to be exercise when they can. Instead of using a “weighted” approach to including the share options, my own calculations are more conservative by including ALL the shares since they are likely to be exercised.

As one can see, the earnings have declined in the past 4 years. In the latest FY16Q1 results, the earnings dropped even more drastic compared to the FY15Q1 results, dropping a whooping 97.5%. What happened?

CDW has been frank about the challenges the business is facing:

“In addition to a very challenging macro-environment, the Group’s key customer, who is focused on the high-end smartphone market, is facing very difficult times from the slowing global demand for smartphones. The key customer’s situation has led to a drop in orders and cost down pressure for the Group over the past year. This situation does not look to improve any time soon and may even deteriorate, depending on how well the key customer and other market players perceive the Group’s new generation light guide”

It is believed that CDW’s main client is SHARP, who is currently financially distressed. The smartphone market, which accounts for the bulk of CDW’s sales, has also been very competitive.

From my discussions with management, I came to understand that upstream suppliers like CDW have to go through a stringent process to get approval as one of the suppliers. This process can take anywhere from 1-2 years, although management said that it is getting shorter.

My opinion is that this forms a natural sort of moat. Clients would be less likely to switch suppliers over a small pricing difference if the accreditation process is so lengthy, and that’d likely involve costs as well.

CDW has recently developed a new generation light guide panel, and given samples for potential clients to assess. This new light guide panel was co developed with a Taiwanese partner (rumored to be Foxconn), and if it is Foxconn, that can only be good news.

These samples have “passed the key customer’s product testing, and the key customer is currently in talks with the end customer“. CDW sits right at the top of the entire supply chain for smart phones. CDW supplies the light guide panels, which are used by smartphone manufacturers to actually assemble the smart phone, which are given to the smartphone companies to sell.

It is this new light guide panel that will determine in a large way, how well CDW does in the short to mid term, possibly the long term as well.

Which is why I describe this as a “unique situation” type of investment. Valuations wise, CDW is certainly on the radar of several value oriented investors.

I won’t get into detail of how undervalued it is, but this is a company that is currently trading at around $0.14+, and it has actual cash on hand of $0.104. The company gives out very attractive dividends of 1.2 US cents, which is approximately 1.65 SG cents, giving a yield of >10%!

How well can this yield be sustained? Let’s take a look at the free cashflow to get a sense of how much cash the company generates, and how of this cash does it get to keep.

Not too bad, generally over the years, pretty FCF generative.

Based on a dividend of 1.2 US cents, the company pays out approximately $6mil in cash in dividends (taking into account the dilution from the share options). In the most recent quarter, it has currently $51.4mil in cash on hand. My opinion is that the FCF and the cash on hand is able to support this dividend at least for the next few years.

Of course, one would’ve observed that the earnings have been declining, and have dropped drastically in the most recent quarter. On top of that, the 1.6 US cents of earnings in FY15 is actually misleading, as there’s an extraordinary gain US $4.9million from the liquidation of a subsidiary, CD Suzhou. Exclude this extraordinary gain, and the earnings is only 0.61 US cents, instead of 1.64 US cents.

As such, the key factor to the immediate future of CDW is the new generation light guide panels. If CDW is successful in getting the key client to place orders, the share price will improve dramatically on such a news. This is because the bulk of the earnings depend on this client. Simply put, the relationship looks like this:

CDW Holding —> Sharp —> Apple

Of course, in reality it’s a bit more complicated than this. Most smartphone companies do not use only 1 manufacturer. They have several manufacturers, with 1 or 2 that becomes their main supplier.

Sharp’s LCD division has been acquired by Foxconn, which is of course known as the manufacturer of Apple phones.

CDW has guided that if they are successful in garnering orders, the manufacturing is due to start in 2HFY16. Which is pretty soon.

I could go on about the detailed analysis of CDW, but that’d make for too long a post and too lengthy reading. The dividends are well supported by CDW’s cashflow and CDW has a long term track record of maintaining, as well as raising it’s dividend. At a yield of >10%, it is indeed very attractive.

CONCLUSION

Here we have a company that’s very attractive valuation wise. But it is not the valuation that’s the key. Rather, it’s “qualitative” factors that’d determine the share price in the mid term. Without the contract win, CDW would likely remain in the doldrums. With a win though, that’d be the key catalyst for a huge jump in the share price.

It’s hard to tell with certainty how it’d play out. I’m betting on a contract win in the 2H of this year. Of course, CDW doesnt form a large part of my portfolio considering that how it’d turn out is currently a known unknown.

At the current share price of 14.6 SG cents, the yield is around 11% +.

At this price, I’m happy to get paid to wait. Might even continue to add a bit to my holdings.