Despec: a net-net at 4x earnings

Despec (company website) is a Turkish company that distributes consumables for the IT sector. The full name of the company is Despec Bilgisayar Pazarlama ve Ticaret AS and the ticker is DESPC:IST.

Annual reports in English can be found here. You need to click on “2012 Operation Report” and then you’ll be able to download the 2012 annual report in English by clicking on the PDF icon. The annual reports for 2011 and 2010 are also available on that page.
If you’re interested in this company you should also check out the research report “Oyak Securities Report” from 05.05.2011 on this page.

The company mainly distributes laser toner and inkjet cartridges. These two categories make up 84% of 2012 revenues. Some other products they distribute are printer ribbon, paper and IT accessories.

Turkey is not a country I would happily invest in. For one thing, it is often hard to get information about companies. There are probably all kinds of governance issues as well. Negative investor sentiment often gets priced in though and this can present bargains that are simply too cheap to ignore. Despec might be one such opportunity.

Share price: 1.65 Turkish Lira (TRY)
Shares outstanding: 23 million
Market cap: 38.0m TRY (about $17 million)
NCAV Dec. 31, 2013: 48.3m TRY
Net income 2013: 8.75m

Despec is currently trading at 4.3x earnings and 0.79x NCAV. Last year’s earnings were not a fluke either, the company earned about 8m in 2012 and almost 10m in 2011. Despec has consistently returned cash to shareholders through dividends. In the last three years the company has paid dividends of 5.0m, 5.1m and 3.1m. The dividends paid in the last three years add up to 36% of the current market cap.

The company offers a detailed description of the developments in the Turkish IT sector and unlike many mature Western markets, there is still a lot of growth ahead for Turkey it seems. PC and internet penetration are steadily climbing. This graphic shows the development of the toners and cartridges market (consumables) since 2005:

Capital and shareholding structure

One thing I don’t like about Despec is the capital and shareholding structure. The company has two classes of shares: “Group A” and “Group B”. There are 22,996,000 publicly traded B shares and just 4,000 A shares that carry this privilege:

“Half plus one of the members of the Board of Directors are elected from the candidates nominated by the Group A shareholders.”

These A shares are owned by a company called “Desbil Teknolojik Ürünler A.Ş.” and they also own 30% of the B shares. Nevres Erol Bilecik owns almost all the shares of Desbil. He is also the chairman of Despec. So Bilecik is in control of Despec and will continue to be, even if he decides to sell off the B shares he holds through Desbil.

Nevres Erol Bilecik is also the majority shareholder of another publicly traded Turkish company called “Indeks” (website). Despec’s annual report mentions that the company is part of the group of Indeks companies. This had me confused for a while, since Indeks does not hold a direct stake in Despec. Bilecik does effectively control Indeks, Desbil and Despec.

This is what the annual reports mentions about Despec’s relationship to Indeks:

“Company’s relations with Indeks Bilgisayar Sistemleri Mühendislik Sanayi ve Ticaret A.Ş. In three main categories are as follows:
I) purchasing and selling products
II) cash usage
III) common expense share
Current account balance have classified in non-commercial receivables and this amount invoiced with interest once in every 3-month.
Some of the commercial product trades are made through Indeks. Accrual of interest in every 3-month when accounts receivable is overdue
Company calculates interest in USD for current account balances in the period. Interest rates which are applied in 2012 vary from 5,30% to 6% and in 2011 vary from 3% to 7,5%.
Indeks A.Ş. Provides mutual usage services to the company. These services consist of personnel costs, meal expenses, office equipment expenses, branch office and branch storage rent expenses and IT repair expenses.”

There are a lot of related party transactions in the annual report. The “non commercial receivables” amounts due to Despec from Indeks and other Bilecik controlled entities declined from 13.7m at the end of 2012 to 4.5m in 2013. This is somewhat reassuring, but I don’t really like the whole structure with all these related entities.

That said, I couldn’t really find anything negative about Nevres Erol Bilecik. He just seems like a successful entrepreneur and I haven’t found any red flags so far.

Supplier dependency

HP is a very important supplier for Despec:

“Purchases from HP covers approximely 50 % – 60 % of total inventory purchases”

(source: Despec annual report 2012)

The research report by Oyak Securities mentions that HP had a market share of 60% in Turkey in 2010. We should expect to see this type of concentration at Despec, since they are the market leader in distributing printer supplies in Turkey according to that same report. It seems unlikely that HP would terminate the relationship with Despec, because they have a leading position, but it would be a major blow if it did happen for some reason.

Re-fills and substitutes

Another risk for Despec is that more and more costumers start using re-fill and substitute products. This is certainly pretty common in my country. The threat of re-fills doesn’t look like an immediate risk though. Despec’s revenues and profits have been relatively stable up to this point. There are also many people and companies that just pay up for the cartridges and keep their hands ink-free.

Credit risk

Despec does business with a large number (around 3000) of resellers. Many of these are small companies that are not that strong financially:

“The company distributes IT supplies to resellers all over Turkey. A large portion of these resellers have low level of capital adequacy when compared to chain stores or large corporate customers. Besides, risk of bankruptcy or change in the ownership is also high for resellers. In times of slowdown in Turkish economy, these smaller customers are likely to face more difficulties in financing purchases as opposed to corporate customers of Despec. However, note that, Despec sells mostly on cash or on credit cards to these kinds of relatively smaller buyers.”

(source: Oyak Securities research report)

“Credit Risk: Capital structure of retailer channel, which is determined as classical vendor in distribution network is low. Not only the ownership these retailers (around 3.000) are handed over frequently, but also their closing and opening rates are significantly high.”

(source: Despec annual report 2012)

A slowdown of the Turkish economy could lead to difficulties in collecting the receivables.

Why is it so cheap?

I struggle to answer this question. The Turkish stock market has sold off recently, along with many other emerging markets. But Despec has been selling off since its IPO in 2010. The company has not really been able to grow revenues much, perhaps that is a reason why investors have given up on the company: Despec has not turned into a compelling growth story so far.

There are certainly some things that are not great about Despec, but does it deserve to trade at 4x earnings and below NCAV? That just looks extremely cheap to me. Especially since the company has been paying large dividends to its shareholders. It’s so cheap that I’m worried I have overlooked something important here and that is one reason why I have not bought the stock yet. I’m also worried, because the stock is fairly liquid: there are many days where more than 100k shares trade. For a microcap with a pretty low float like Despec that is very liquid. I’m more willing to accept that something is a great bargain when a stock is very small and illiquid. When a stock has more liquidity, I begin to think like the economist who walks by a $100 bill without picking it up, because it must be fake. If I find many more bargains in Turkey this becomes less of a concern, but now it just seems a little too good to be true.

That said, Despec’s valuation and the dividend payments make me inclined to buy a small position if my broker can help me out.

I hope some of you will take a look at Despec and perhaps provide some insight into the company and the current valuation. Comments are welcome below. You can also reach me by e-mailing to info at valueinvestingblog.net or through the contact form.

Disclosure: no position in Despec at the time of publication.