Dalsa's unnecessary putsch

Saavas, I hate to say I told you so…. (“Saavas, keep your chin up!“, January 31-08).

A few short weeks ago, Dalsa’s (DSA:TSX) board agreed to turn itself inside out with the appointment of three new directors: Eric Rosenfeld (aka “The Crooner”©), Mark Burton and Colin D. Watson. This was in response to Mr. Rosenfeld’s announcement that his hedge fund had acquired more than 10% of Dalsa’s outstanding shares. Bay Street folks were primed for the fusillade to come.

Dalsa’s board clearly feared that Crescendo would win a proxy battle, so they went along with what one could call “an offer they couldn’t refuse”, and voluntarily appointed Mr. Rosenfeld’s mini-slate last month.

The truth is, there aren’t two better independent directors for Dalsa than Messers Burton (see prior post “Longview Solutions to be acquired by Exact Software” September 17-07) and Watson. I’ve seen them both in action, and they are top notch people, both professionally and personally. Mr. Rosenfeld is incredibly fortunate to be in their midst, and Dalsa will benefit from their advice and experience.

But with the news out last night that Dalsa’s Q1 2008 results will far exceed analyst expectations, it must be said that Crescendo’s putsch appears to have been entirely unnecessary.

Hedge funds are supposed to make a difference (“add value”) if they want to legitimately claim their 80/20 upside split; riding the coattails of others doesn’t quite cut it.

Dalsa’s board had already addressed stagnating revenue with the appointment of a new CEO in 2007. Costs had been cut, and the digitial business was starting to get real traction last Fall (see prior post “Activist investor already having impact at Dalsa” March 25-08). The fruits of these many labours are just now being borne, but there’s no question that Dalsa had been on the right track, long before the hedge funds showed up on the scene to provide their particular type of value add (“okay boys and girls, time to sell this pig”).

Some situations definitely call for activists: Creo, for example, needed to pull back on the $50 million in unnecessary R&D spend that it was doing, year-in-and-year-out; it was eventually acquired after a misguided bought deal laid out a bunch of institutions. ATS Automation was another situation where the market had lost confidence in the team and the solar strategy (see prior post “ATS shareholders find their tonic” November 21-07); it needed a change agent.

But there are a bunch of situations where the arrival of activists reminds me of Conrad Black; being born standing on third base makes you think more of your business accumen than is probably warranted. Geac and Dalsa are two of those examples. That their shares went up after the hedgies got involved is merely a coincidence.

Just as the current Lord Thomson of Fleet doesn’t take personal credit for building the initial Thomson fortune, it takes a classy hedge fund manager to acknowledge when they happen to find a winning lottery ticket on a Waterloo sidewalk.

For the portfolio managers at Saxon Financial and Franklin Templeton, the fact that Dalsa’s shares are up $6 this year appears to be entirely due to the strategy and hard work of Dalsa’s management team and prior Board of Directors – and the patience of their shareholders over the past few quarters. Tech innovations can’t be built overnight, and much of Dalsa’s new growth opportunities needed time to mature; just like a fine Bordeaux wine.

One has to wonder if you put certain hedge fund managers in charge of Chateau Margaux, would they throw out the 2006 vintage after a single swig – the stuff not yet being drinkable. Off with the Vintner’s head!

Sometimes, patience is the key to building (and rebuilding) public companies. Dalsa’s share price appreciation this year is just another example.

It certainly isn’t a scalp for the wall of New York hedge funds, and one can only hope that Canadian mutual fund PMs remember that the next time a hedge fund comes knocking, looking for their support for their latest proxy battle.

Here is GMP’s take on the news:

“In a press release issued yesterday (March 28) Dalsa Corp. (DSA) announced that it is continuing to see strong product demand in its Digital Imaging and Semiconductor businesses and is expecting to report a sharp increase in revenue and earnings in the first quarter of 2008.
The flat panel display inspection orders are strong and DSA is winning market share with key new products in the higher volume industrial segment. In the SEMI division, revenue and profitability is being bolstered by strong shipments of advanced CMOS wafers and high demand from MEMs customers.

Management expects revenue to be higher than $50m in Q1 08 and EPS at least $0.17

Management has commented that the combination of robust product demand and the company’s renewed focus on operational efficiency and product mix will contribute to much improved performance in 2008. Management also commented that for the first time in DALSA’s history it is expecting revenues of greater than $50m in the first quarter, and is anticipating EPS of at least $0.17 on a fully diluted basis.

While management provided comments only on Q1, we have adjusted our revenue and earnings
estimates for both Q1 and Q2 in the Semi division to reflect the positive outlook in this announcement and our expectation that solid order intake will drive stronger results than we had previously forecast.

We continue to expect a weaker 2H reflecting a contracting U.S. economy. We have left our DIP division numbers unchanged as we had already modeled a substantial uptake in that business. We are not prepared to make any adjustments to our forecast for the second half of 2008 given the limited visibility that DSA’s order intake and backlog have historically conveyed – the lag between order intake and delivery is relatively short and therefore there is no real depth to this company’s backlog making future revenue difficult to infer from current levels. We note that application specific contracts have a longer duration but these represent a small percentage of quarterly revenue.

For 2008 in the Semi division, our Q1 revenue forecast increases from $20.3 to $22.7 and Q2 rises from $20.1 to $21.2. Net income margins in the first and second quarters of 2008 expand from 6% in each to 9.5% and 10% respectively. As a result Q1earnings become $0.18 from $0.13 previously and Q2 becomes $0.19 from $0.13 previously.

To arrive at our target, we continue to apply a 20x earnings multiple to our 2008 EPS forecast which increases to $0.63 from $0.53 previously. This yields our core fundamental value of $12.60. We continue to believe that the elimination of the earnings drag from the Digital Cinema business could surface up to another $8.00 per share in value, which presents a call option on the stock. To our core fundamental value of $12.60 we add a 50% optionality of the company realizing this value or $4.00, reflecting the representation of Crescendo Partners on the board. This yields a new target of $16.60, up from $14.60 previously.

We reiterate our Buy recommendation”

MRM