Description

While the Space Race era largely ended in 1972-1973 with the final Saturn V launches, a new bull market in SpaceTech has been recently raging. In addition to SpaceX and Blue Origin, hundreds of private space-related companies (new aircraft, satellites, rockets, etc.) have been founded and funded in recent years.

In the public markets, besides large caps like Transdigm and Boeing, perhaps a nanocap or small-cap name is worth investigating. We like Giga-Tronics (OTCQB: GIGA) because the company is fairly valued based on its legacy filter business and has a new product line with significant potential (catalyst).

Incorporated in 1980, GIGA has a four-decade history, though of erratic sales and earnings. In 1998, the company acquired Microsource, its microsource filter business unit. Led by long-time CEO John Regazzi and Executive VP Lutz Henckels, GIGA has recently developed a new line of Radar/EW test equipment that has significant potential.

MICROSOURCE FILTERS

GIGA is the sole source provider of customized filters for F/A-18 (starting in 2008), F-15 (starting in 2013), F-16 (starting in 2016) fighter jets. These filters protect each plane from its own radar and power system in a dynamic way. When Microsource was acquired in 1998, Microsource had invested $19 M in developing these filters. The filters cost roughly $35,000 for a single and $85,000 for a dual.

New fighter jets, such as F-22 and F-35, have fast, optical systems. They do not need these filters. That means that GIGA is tasked with only upgrading the old, active fighter jet models with these filters. There are still over 3,300 legacy planes (half domestic, half foreign) that need to be upgraded with these filters. The filter orders generally come from Boeing or Lockheed, which designed the original jets.

GIGA has been named the sole source provider of these filters, which cannot be reverse engineered because part of the engineering is classified. GIGA has 44 employees, including 17 engineers and 20 employees with military security clearances. At its facility, the filters are tested at extreme temperature (-80 degrees Celsius, with liquid nitrogen) and programmed in a private room with a top secret, classified frequency.

In recent years, microsource filter revenue has varied from $7-9 M, with 35-40% gross margin. Most recently, microsource filter revenue was $9.4 M for F21 (March), up from $8.2 M for F20. In F21, GIGA supplied filters for 170 fighter jets (roughly 5% of remaining legacy planes that need to be upgraded).

Executive VP Lutz Henckels, who is a bit of a character and is the 14^th generation of the founder of Henckels’ knives (founded 1731), refers to this business unit as “the rock” of the company because it provides consistent cash flow for the company to achieve break-even.

RADAR/EW (Electronic Warefare) Threat Emulation Systems

In recent years, GIGA has spent $23 M developing and patenting (5 awarded patents with more pending) its RADAR/EW systems. The overall annual market for RADAR/EW threat emulation is roughly $440 M. These systems are used in the field to train fighter pilots to jam specific radar and electronic threats that they may face when flying over unfriendly borders (e.g. air defenses of Russia, China). GIGA’s systems generally have 10-50 emitters, which emit a stream of pulses at the fighter jet at various frequencies, very quickly.  

GIGA’s new systems have advantages, such as 1) real-time and dynamic, while still operating in a closed-loop, 2) small format that is more portable in the field, 3) lower cost (partly due to the smaller size) than traditional systems, and 4) new ability to record and playback. Think of a portable trailer with a rack of computers that is placed in a military field and pointed at pilots flying overhead (to assist in their training).

This business unit had $3.7 M in sales for F21 (March), up from $3.5 M in F20 and $1.9 M in F19. Gross margin is similar to microsource filters at 35-40%. Orders have come from both the U.S. Navy and U.S. Air Force. Anecdotally (per me pestering them a bit), the company has delivered systems to Pt. Mugu (Navy base in SoCal), China Lake (Navy base in SoCal), Eglin (Air Force base in Florida), and Sandia (National Lab in New Mexico). Competitors in this $440 M market include Keysight (sells 50 systems a year at about $250K each), Rohde & Schwarz, National Instruments, ELCOM (a division of Frequency Electronics Inc.), VIAVI, EWST (a division of Ultra Electronics Plc), Northrop Grumman/Amherst and Textron/AAI.  

Due to COVID-19 in 2020, GIGA’s key salespeople and engineering team could not enter U.S. military bases without first self-quarantining themselves for two weeks. That process slowed down the company’s sales plans. As COVID-19 subsides, GIGA should make continued penetration of its accounts. Also, GIGA is rolling out new functionality (i.e. playback, record) in these systems. A typical system costs $750K, which could rise to $1.5 M with the added functionality.

VALUATION

Overall, GIGA had adjusted EBITDA of $311K for F21, versus $185K for F20. If the company can grow its RADAR/EW unit to $10 M in sales (up from $3.7 M and significantly lower than the long-term goal of $60 M), then GIGA’s gross profit could be $7.4 M. With historical SG&A of $5.0 M for F19 and F20, that would imply $2.4 M in EBIT. A 15x multiple (significant tax loss carryforwards) implies $36 M market cap, or $9.5 stock, up +170% from current levels. Note that Danaher purportedly offered to buy the company for the same valuation of $36 M back in 2009. Perhaps the company would entertain that valuation again.

RISKS

Insider ownership low at 9%.

Some recent dilution: on April 27, 2001, the company raised $1.5 M, or $3.25 per 461,538 shares.

As of March 27, 2021, backlog was $5.1 million down from $6.8 million at March 28, 2020, indicating some recent slowness.

Catalyst

Company recently cash flow positive

Continued growth of RADAR/EW Threat Emulation Systems

Potential acquisition in-line with historical interest at $9+ per share