In the last week, Optex Systems Hldg InCorp (OTCMKTS:OPXS) has announced two major developments. The first, the winning of a five year deal with US government Agency The Defense Logistics Agency. The contract is worth just shy of $6 million, outweighing Optex’s entire market capitalization by more than $2 million, and its announcing injected some immediate upside into the company’s share price. The second, filed with the SEC on the same day as the contract announcement, is an equities offering, targeting the issue of 5 million shares common and a further 750K warrants (we’ll discuss these in a little more detail shortly).
The combination of these two developments serves up something of a tough predicament. The government contract is a real win, and reinforces (to some extent) the near to medium term operational security of Optex. The issue is representative of expansion, and in that sense a good thing, but it’s going to bring some serious dilution to the table – dilution that right now shareholders can’t afford to to shoulder.
Let’s try and come down on one side of the fence.
For readers not familiar with the company, it’s an optical technology company that primarily serves the military, but also has a few commercial customers. It makes periscopes and other targeting equipment, and commands a pretty impressive penetration in the sector – something in the region of 75% market share in the periscopes & vision block in the US, and 20-30% worldwide. The latest deal will see it provide $5.99 million worth of its laser protected periscopes to the Defense Logistics Agency across the next half decade, and – just as importantly – should reinforce a few outstanding bids the company has on other projects. Danny Schoening, CEO, supports this thesis with this statement:
“Winning the bid on this multi-year agreement demonstrates our capability to execute on this strategy. Given our strong IP, our excellent proven military products and a pipeline of new commercial products, we anticipate many more exciting contracts in the coming months.”
Each of these contracts has the potential to be an upside catalyst, so it could be an interesting few months from a buy side perspective.
Unfortunately, there’s very little positive we can say about the company’s capital structure. Current stock outstanding comes to a little over 1.73 million shares. Outstanding options would result in the issuance (on exercise) of around 53K shares – that’s not too big a deal. However, there are series A and B preferred that, if converted, would flood the market with more than 2 million additional shares.
That’s not all. The preferred shared have priority in the event of liquidation, and the company’s current assets don’t cover the fully realized value of the series A and B. In other words, if the company goes into liquidation, any common stock is literally worthless.
“Furthermore, in the event of liquidation, the holders of our Series A preferred stock and Series B preferred stock would receive priority liquidation payments before payments to common shareholders equal to the amount of the stated value of the preferred stock before any distributions would be made to our common shareholders. The total stated value of our preferred stock is $5,051,425, so the preferred shareholders would be entitled to receive the amount of the stated value before any distributions could be made to common shareholders. The liabilities on our balance sheet exceed the liquidation value of our assets; therefore, upon liquidation, there would be no assets remaining for distribution to common shareholders.”
And there’s more to come:
“As a key component of our growth strategy we have provided and intend to continue offering compensation packages to our management and employees that emphasize equity-based compensation and would thus cause further dilution.”
So basically, this is an all or nothing situation. Buying into the upcoming issue is immediately dilutive, and holdings look set for heavy dilution near term. If the company goes under, you get nothing. On the other hand, it’s current market cap looks deeply unrepresentative of the company’s prospects if you remove the capital structure risk from the equation. If it can grow to the point that the dilution impact is mitigated, there’s plenty of reward on offer.
So which side of the fence are we settling on? For us, there is too much dilution in the pipeline to justify an exposure. This doesn’t mean the company is not worth considering, but we’d like to see it sort out its capital structure before picking up an interest.
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Disclosure: We have no position in OPXS and have not been compensated for this article.