Date of publish: 15 May 2019

OPXS write up

Current share price: $2/share

Curr EV/Tot Revenue (LFY): 0.76
Curr EV/EBITDA (LFY): 8.79
Curr EV/EBIT (LFY): 10.73
Curr Mkt Cap (m): 16.78
Insider ownership: 33.99%

Thesis:
OPXS is a monopoly in selling laser-protected periscopes to the US military. It has not lost a
single contract in recent years after the previous major competitor went bankrupt 4 to 5 years
ago (of which they actually bought assets from them). There is also strong tailwinds in
multiple areas of their businesses (such as US army’s increased spending on Abrams tanks).
All these factors has led to a steady increase in gross margin and revenue every year in recent
years (as seen below). I believe the main reason why it is not being appreciated by the market
right now is because it is trading on the OTC market, as such, most investment firms are
unable to invest in it.

With the US military increasing its spending on Abrams tanks, there is bound to be more
industrial tailwind that would benefit OPXS, not to mention that management has also stated
that they are planning on developing its commercial segment so that it would eventually
reach 50% of total revenue. There is also industrial tailwind for this segment as the riflescope
market is expected to grow from USD 5.36 bil in 2016 to 6.87 bil in 2022.
With OPXS currently trading at around EV/revenue of 0.76x and EV/EBITDA of 8.8x and no
debt, I believe that this is presents a rather compelling risk to reward.
Business overview
OPXS manufactures optical sighting systems and assemblies, primarily for Department of
Defense applications. Their products are installed on various types of U.S. military land
vehicles, such as the Abrams and Bradley fighting vehicles, light armored and armored
security vehicles and have been selected for installation on the Stryker family of
vehicles. They also manufacture and deliver numerous periscope configurations, rifle and
surveillance sights and night vision optical assemblies.

Products
OPXS has 2 main products
1) Periscopes and vision blocks market. The Price point for these products are between 500
to 1000 dollars per unit. OPXS occupies around 75% market share for periscope and vision
blocks in the US market, but it is approaching 100% gradually. They are trying to push the
same product set into the worldwide market as it is readily accepted as the gold standard by
the US market, and they are trying to push the same value into Europe

2) Sighting systems market. For this segment, the price point is between 4000 up to 20,000.
They are a Smaller player there, but gaining some traction because of their nice cost structure.
There is only a sighting systems (domestic) competitor left by the name of Seiler instrument.
They are currently competing with Seiler Instruments for fire control products. These
contracts are higher value products, but lower in quantities. Given the expense of
development and qualification testing, the barrier to entry is high for new competitors.
Management team
I believe that this is a top notch management team as many players has worked for large
companies and as the CEO has stated, they have a large company’s discipline and also a small
company ability to move fast. Below is a profile of the management team.

Plan for business expansion

Organic growth strategy:
The company is planning to continue pushing their products that into Europe. They are doing
so by getting into the same vehicle that are made by USA’s allies in that space. In terms of
new product development, the first people that they take their technology to is their existing
customers, and that keep the customers tight with the engineering community of the
company and make sure they are kept in the loop. They also started to Diversify their
customer base by launching products on ecommerce platforms. They recently launched some
products into amazon and cabela’s

Acquisition strategy:
Exponential growth would occur from either a product line acquisition or straight business
acquisition. Past example of acquisition would be L3 communications 4 years ago, which
allowed them for vertical integration and expand their sales into the commercial space. They
are not interested in paying double digit ebitda multiple acquisition and are looking for small
suppliers that have niche product similar to optex that are also in the military space, from this
you can kind of tell that they have a very disciplined management team and acquisition
strategy. So any opportunities with either similar customer sets or integrated within the
supply chain would be target for acquisition.

Valuation
I used an unconventional method of valuation called the earnings power value (EPV) to value
this company as it is important to understand how much the market is paying for the growth
of this company. This valuation technique works especially well in markets with little
competition and few comparable. Again, the valuation methodology is not one that is aimed
at precision, rather it is one that helps the readers to understand how much they are paying
for growth. I assumed the beta to be 12% in this case. Putting beta to be between 10% to 15%
gives intrinsic value (diluted) of $1.40/share to $2.07/share.

FY 2018 EBIT 1,486.00

option expense 56.99
depreciation (30.40)
net interest expense -
SG&A Add back 757.25
Pre-tax income 2,269.84
Tax (assumed to be 25%) 567.46
Normalised Earnings 1,702.38

Cost of Equity (not beta) 12%

EPV 14,186.53
Cash from Options 506.00
Adj EPV 14,692.53
share count 8,458.47
diluted share count 8,795.80
intrinsic value (diluted) 1.67
 intrinsic value 1.74

Interpretation of the model:

Given that intrinsic value (diluted) derived from the EPV is $1.67/share, it means that an
investor is only paying $0.33/share for growth, which is 16.5% of the current stock price.
Given the monopolistic nature of this business, coupled with strong and predictable tailwinds,
I believe that this is a compelling investment.

Risks:
There major risk of this business comes from to the high customer concentration, as over 80%
of sales come from these 4 customers. U.S. government agencies, Nightforce Optics, Inc.,
General Dynamics, Harris Corporation. However at the same time, there isn’t much
substitutes for the customers as well.
Management has also stated that one of the biggest risk of OPXS is peace. The reason is pretty
self explanatory.
Updates:
During the three and six months ended March 31, 2019, they experienced product revenue
growth of 55.8% and 39.2% and improved gross margin percentages of 6.1% and 3.8%,
respectively, over the three and six months ended April 1, 2018.

Revenue growth was primarily concentrated in the Optex-Richardson segment, which

represents a 100.2% increase over the prior year second quarter and a 69.9% increase for the
six month period. The Applied Optics Center realized a 9.5% and 3.8% increase in revenue
during the three and six months ended March 31, 2019 as compared to the prior year periods.
Revenue growth for both segments is primarily driven by increased defense spending on our
periscopes, Applied Optics Center laser filters and other product lines. Gross margin
performance improvements were driven by revenue shifts from the less profitable
commercial products toward higher margin military laser filters at our Applied Optics Center
segment, and favorable changes in the "fixed" manufacturing overhead costs as a percentage
of the significantly increased revenue at the Optex Richardson segment.