RISKS

• Highly commoditized industry with fierce competition and pricing pressure. Because of this industry dynamic, Nam Tai has little leverage to pass on pricing or even enforce contractual violations due to the need to preserve customer relations.
• As recently as 2007, the company was pushing to expand into the TCA segment, which has by far the lowest margins of the 3 operating segments (TCA = 5% gross margin vs. CECP: 29% & LCDP: 16% in 2007).

• TCA segment has dropped significantly (over 50% decline in Q2 08) due to pressures in the mobile phone industry.

• The company plans on $80M annual capex in 2008 and 2009, largely to expand FPC production capacity related to the TCA segment.

• Nam Tai has to deal with an uncertain regulatory environment as the bulk of their operations occur on mainland China. For example, the PRC has recently changed favorable tax and labors laws to the detriment of corporations. Other adverse regulatory changes can happen in the future.
• Customer concentration risk exists as 10% of their customer base accounted for nearly half of sales in 2007, a trend that is unlikely to change.
• The company is dependent on good international relations to an extent. In 2007, sales to Japanese companies comprised 36% of net sales and over half in the 2 previous years. Any strain between Japan and China may impact Nam Tai’s business.
• As noted previously, the company is planning substantial capex over the next two years. If the global economy and specifically, the consumer electronics industry, does not rebound, Nam Tai could be left with substantial spare capacity which would impact business results.
• Beginning in 2007, the company began experiencing a sharp drop in its TCA segment, which has continued into 2008 and as of last quarter, has spread to the LCDP and CECP segments, though less dramatically. While the company projects 15% growth for the 2nd half of 2008 compared to the 1st, the global economy seems to be slowing and management projections may not come to fruition.

• The LCDP segment has slipped into net losses as of Q2 2008.

• Management projects a rebound in the TCA segment, which has much lower margins.

• NTE trades relatively low volumes on the NYSE, averaging 197,000 shares daily volume. Low liquidity may affect investor ability to maximize entry & exit prices or use derivatives to hedge risk. However, I do not see much of a risk of NTE delisting from the NYSE as it is not currently listed on any other exchanges (though several of its subsidiaries are listed in Hong Kong).
• Much of the company’s income statement comprises of activity separate from operations, such as gains on marketable securities, dividends, etc.

UPSIDE POTENTIAL

• An impregnable balance sheet with no debt and over $6 cash per share.
• Despite the commoditized industry the company operates in, Nam Tai has managed to deliver strong returns on invested capital. My numbers show 30% ROIC, even after including depreciation to account for additional capex. The company’s modified earnings yield (EBIT/EV) comes in at 31%, also after I’ve adjusted for EBIT to exclude other income.
• The company projects a 15% rebound for the 2nd half of 2008 compared to the first 6 months. The TCA segment is estimated to show 40% growth and LCDP 15% growth, which should bring it back into profitability.