The case subject revolves around MiniScribe, a manufacturer of disk storage products that is under the watch list for rumors directed to the firm’s problems with cash flow and inventory. The objective of the report is to come up with a BUY OR DON’T BUY recommendation for Alexander & Ferris using the available financial and qualitative information.
The analysis was conducted by deriving additional information from available financial data and proceeding with an interpretation of the results in light of qualitative information. The group developed decision lists for a BUY or DON’T BUY recommendation and these were compared against relevant factors that assess the profitability, efficiency, and sustainability of a company.
Following a thorough analysis of the financial statements, financial ratios, and industry trends, the decision is to proceed with a DON’T BUY recommendation. On the evaluation of profitability, expenses are increasing at a faster rate than sales, and cash flow generated by operating activities is steadily declining, even reaching negative values towards the third quarter. MiniScribe’s position on research and development investments, while it maintains its good reputation in the stock market, is too high to maintain considering the firm’s depleting cash resources. As expenses increase, problems in cash flow and asset management become more and more significant. MiniScribe’s resources are locked in rapidly increasing inventories and A/R balances as indicated by increasing turnover days. Inefficient inventory management and long collection periods lead to more doubts on MiniScribe’s ability to remain liquid. Further pursuing this analysis, liquidity is a prime concern because MiniScribe has been resorting to short-term borrowings and debt to address its cash flow problems. With decreasing cash balances and increasing current liabilities, MiniScribe’s uncontrolled short-term debt raises uncertainty in the company’s sustainability.
MiniScribe must be placed on a DON’T BUY recommendation because its current position does not pave way for continued high earnings for investors. I. POINT-OF-VIEW
The analysis of Miniscribe Corporation’s financial performance will be taken from Paula Perry’s perspective as a research analyst for Alexander & Ferris, a brokerage firm.
II. CASE CONTEXT
While once a promising investment in its early life, Miniscribe is rumored to be experiencing cash flow and inventory problems after a management takeover and restructuring.
Brief History of Miniscribe:
1. Entered the market and posted soaring revenues; Was once Wall Street’s favorite 2. Lost its momentum and severely went down when its customers (IBM) started producing their own disk-drives 3. Invested in R&D which earned them a good reputation and stock prices that continuously increased 4. The state of the market is looking bleak and MiniScribe’s financial statements show that the company is not performing well 5. Future plans of MiniScribe: diversify products to infiltrate new market segments Should Alexander & Ferris, a brokerage firm , continue to retain Miniscribe on its “Buy” Recommendation List?
III. PROBLEM DEFINITION
The report intends to come up with a BUY or DON’T BUY recommendation for Alexander & Ferris, as supported by the group’s in-depth analysis of available quantitative and qualitative Information.
The analytical methodology requires the following:
1. Definition of the criteria or factors for consideration for the recommendation; 2. Organization of available data, which includes the following: 1. Historical recording of events that transpired from 1980-1988 comparing company and industry reviews, 2. Preparation of Financial Statements (Income Statement and Balance Sheet for 1st-3rd Quarter of 1988); 1. Extraction of additional information from available data to realize the following data: 1. Profitability, Liquidity, Asset Management, and Financial Leverage Ratios; 2. Trends for company performance and industry performance; 1. Identification of relevant data to be used for analysis; 2. Interpretation of quantitative data in light of qualitative data, and vice-versa through: 1. Benchmarking with the industry;
2. Examination of financial statements and matching the findings from analysis with events and movements within the industry; and 3. Development of decision lists supportive of choice recommendation – BUY or DON’T BUY; 1. Comparison of the decision factors created with the criteria established to arrive at a decision
To help the group analyze which decision to pursue, the group comparisons which supports quantitative and qualitative information from recommending to BUY or NOT TO BUY. A. Support to keep MiniScribe in the recommendation list
There are five points to keep MiniScribe in the recommendation list, as evidenced by quantitative and qualitative data derived by the group, as follows:
First, sales stay positive and is relatively stable as evidenced in Exhibit 1. Consolidated Income Statement and in Exhibit 2. Horizontal Analysis – Trend Percentages of the Income Statement.
Exhibit 1. Consolidated Income Statement
Exhibit 2. Horizontal Analysis – Trend Percentages of the Income Statement
This shows that its products are still saleable. It is also evidenced that there is increasing demand for 3 1/2-inch disk drives. MiniScribe dominated the 3 1/2-inch-drive market.
Second, the company has a positive bottom line, or Net Income, that leads to positive income per share. This is evidenced as well in Exhibit 1. Consolidated Income Statement. It shows that MiniScribe is still profitable and investors may still hold their shares in the company.
Third, MiniScribe still has positive and stable Return on Equity as evidenced in Exhibit 3.
Exhibit 3. Return on Equity
This can be much explained using Du Pont Equation and through analyzing the information, shown in Exhibit 4. Du Pont Analysis, even though cost management is somehow ineffective, the company still generates income and investments can be done from this and other sources of financing.
Exhibit 4. Du Pont Analysis
Fourth, MiniScribe has a good reputation for their R&D Commitment. Investment activities are high as evidenced in Exhibit 5. Consolidated Statement of Cash Flow.
Exhibit 5. Consolidated Statement of Cash Flow
This shows that Property, Plant, and Equipment was given priority for Research and Development activities, which ranked third in the expenses with most spending, as evidenced in Exhibit 6. Vertical Analysis – Common Size of the Income Statement.
Exhibit 6. Vertical Analysis – Common Size of the Income Statement
Also, in 1987, Electronic Business, a leading trade journal, ranked Miniscribe second in R&D spending with a 131.7% increase over 1986. Further pursuing this branding strategy, it is a likely the case that MiniScribe earned itself a loyal following.
Fifth, MiniScribe plans to diversify and explore other market segments. Investment activities are high as evidenced in Exhibit 5. Consolidated Statement of Cash Flow, seen above. There’s also a drastic increase in Research and Development expense as evidenced in Exhibit 2. Horizontal Analysis – Trend Percentages of the Income Statement above. This shows that MiniScribe has good plans in building new products so they can take the lead in the market. This is also evidenced that due to rapid technological change, the US PC market is going down and MiniScribe responds by planning diversify its product lines to accommodate other market segments, like disk drives for FAX machines, laser printers, and photocopiers.
Lastly, Miniscribe shares’ price is above industry level when the industry faced a declining shares price. This is evidenced in Exhibit 7. MiniScribe vs. Industry Share Price.
Exhibit 7. MiniScribe vs. Industry Share Price
Maintaining shares’ price to be above the industry level have been brought by dominating the 3 1/2-inch disc drive market, which had expected orders to total 10M, 45% market share and continued effort in developing new products and innovations through investing in research and development.
B. Support to take MiniScribe out of the recommendation list
Following the analysis of the current financial situation of MiniScribe against the context of industry trends and the company’s history, the decision is for Alexander & Ferris to pursue a DON’T BUY recommendation.
VII. SUPPORT (BASIC JUSTIFICATIONS)
MiniScribe and its shares are not performing well based on the count of profitability, cash flow, and debt standing.
1. Profitability – The main factors used in evaluating profitability are sales, operating expenses, and the resulting net income.
Sales of MiniScribe have shown declining growth rates. To raise growth rates in sales will pose difficulty due to the state of overcapacity in the industry and the rise of competing firms. Expenses are growing at a much faster rate than sales which deplete net income and earnings available to shareholders. Specifically on R&D, expenses are increasing at high rates and this will continue to increase with the planned attempt to diversify product lines. This level of spending entail risk and more expenses, which MiniScribe can no longer afford given the trend in sales and considering the depleting cash resources generated by operating and financing activities.
2. Efficiency and Cash Flow – An evaluation of cash flow leads to critical business findings on a firm’s efficiency and operating activities that also gives an indication on the sustainability of a firm.
A/R and Inventories. The company’s liquid resources are hampered by rapidly increasing inventories and A/R balances. Risky possibilities come with increasing receivables and collection periods where effects can hurt cash flow and result to borrowings and its associated expenses. Similarly, inventories are rapidly increasing which poses a problem because these stocks may soon become obsolete, considering the ongoing technological advancements in the market. Due to long collection periods and low inventory turnover, cash generated by operating activities is at a continuous decline, dropping to negative values on the 3rd quarter.
Cash balances are going down because resources are trapped in unmoving inventories and uncollected receivables. These inefficiencies in the management of assets infer uncertainty in MiniScribe’s ability to generate
positive future net cash flows.
3. Debt vs. Liquidity – Uncontrolled debt can lead to higher costs, losses, and even bankruptcy.
As a response to depleting cash resources, MiniScribe relies heavily on short-term borrowings. However, the company’s operations do not generate enough cash to pay off these liabilities. Cash (and equivalents) to current liabilities ratio is very low and MiniScribe’s ability to meet its obligations is questionable. Short-term borrowings continue to burden the company with expenses that its current assets will not be able to meet.
The future of MiniScribe does not look promising. Sales are at declining growth rates and these posted revenues are mostly in accounts receivable. Accounts receivables revolve around long collection periods and this is matched with low inventory turnover. To retain positive cash balances, the firm has to resort to borrowings. However, the inefficiencies around asset management lead to problems with liquidity and inability to meet rapidly soaring short-term borrowings and accounts payable balances. Given its current financial condition and foreseeable future (at least in 1-2 years), MiniScribe is not a good buy for investors who seek investments with a high earning potential or shares for which they can anticipate an increase in value.
VIII. OPERATIONALIZING DECISION
The course of action following the DON’T BUY recommendation is outlined below:
1. Alexander & Ferris to place MiniScribe under a DON’T BUY recommendation
2. Alexander & Ferris to periodically evaluate MiniScribe against other companies within the same sector.
a. Significant improvements in sales trends, solvency ratios, inventory management, and the collection of accounts receivable balances should
initiate a review and if valid, a reconsideration of the recommendation.
Exhibit 8. Horizontal Analysis – Trend Percentages of the Income Statement Graph
Exhibit 9. Consolidated Balance Sheet
Exhibit 10. Horizontal Analysis – Trend Percentages of the Balance Sheet
Exhibit 11. Horizontal Analysis – Trend Percentages of the Balance Sheet Graph
Exhibit 12. Vertical Analysis – Common Size of the Balance Sheet
Exhibit 13. Computation of Purchases
Exhibit 14. Profitability Ratios
Exhibit 15. MiniScribe vs. Industry Liquidity Ratios
Exhibit 16. Miniscribe vs. Industry Current Ratio
Exhibit 17. Miniscribe vs. Industry Quick Ratio
Exhibit 18. Miniscribe vs. Industry Current Liabilities to Net Worth Ratio
Exhibit 19. Miniscribe vs. Industry Total Liabilities to Net Worth Ratio
Exhibit 20. MiniScribe vs. Industry Asset Management Ratios
Exhibit 21. MiniScribe Leverage Ratios
EXHIBIT 22. Historical Overview
DATE| MINISCRIBE| INDUSTRY| ANALYSIS|
1980| Terry Johnson started Miniscribe Corporation| | | Oct-81| First Shipment| | |
1981| $81,000 Sales| | |
1983| $77M Sales| | The rapid growth of Miniscribe, for the greater part, can be attributed to IBM’s orders, which accounted for 61% of their sales. Consequently, the company is vulnerable to the purchasing activities of IBM. | | IBM accounted for 61% of Sales| | | Nov-83| IPO at $11.50/share| | | Jan-84| IBM cancelled/rescheduled orders| SHAKE-OUT| SHAKE-OUT| | Growth of microcomputer industry slowed significantly| | | 2H 1984 – 1H 1985| Reduced sales, large losses, heavy R&D spending and major capital expenditures (Singapore Facility)| | | 1Q 1985| Severe liquidity crisis| | MINISCRIBE: CRITICAL| 2Q 1985|
Hembrecht & Quist (venture-capital firm) infused $20M capital| | While Miniscribe’s cashflow management was questionnable, their move to invest in offshore facilities must have been a good one since it attracted venture-capitalist Hembrecht & Quist | | Q.T. Wiles, Chairman of the Board of Hembrecht & Quist, became Chairman of the Board and CEO of Miniscribe: Positive Image/Reputation| | | | Realigned Senior Management and Organization Structure| | | | Reorganization focused on arranging firm into 5 specialized divisions, resulting in the entire company operating with a renewed entrepreneurial spirit: Financial results became the sole determinant for employee incentives and benefits| | | | Aggressive Financial Management| | MINISCRIBE: REBOUND| 3Q 1985| Resurgence in Sales: Profitable again| | Miniscribe’s leadership and organizational restructuring and fiscal controls must have been the missing ingredients for the company’s success. The renewed image of the firm may have attracted Wall Street again as share prices rebounded from a slump. | | New products received well by market; Favorable technical reviews| | | | Sales made to to both just-in-time distributors and major computed companies such as Apple, Digital Equipment, and CompuAdd| | | 1987| To maintain market share, emphasized R&D commitment;
Electronic Business, a leading trade journal, ranked Miniscribe second in R&D spending increases with a 131.7% increase over 1986| Major competitors of Seagate Technology (Computer Memories, Micropolis, Maxtor, Quantum, and Priam) had combined sales of less than $1 Billion for the year| Miniscribe’s Common Stock Prices from 1986-1988 reflects the company’s claims, how it rebounded from its 1985 flop and how its share prices grew from 1895 to 1988.| | Stock prices reflected positive information: Share price rebounded from a low of $1 in 1985 to $13 in July 1988| | Miniscribe’s common stock prices reflects a steep decline between 1987-1988, which was disregarded in the company’s reports. | 1987-1988| | Four new companies entered the industry, marking the first entrants, since 1984 shake-out| | 1988| | Disk-drive industry dominated by Seagate Technology with Sales over $1.3 Billion| | 3Q 1988| Became the second largest producer of disk drives in the US| | Miniscribe seemed to have come from nowehere by 3Q 1988. In 1987, it wasn’t even considered a major competitor of Seagate, when they were supposedly profitable again. We might have to assess if this is just a Game of Perception, as is the case in Wall Street with rumors and negative publicity posting grave effects on share prices.| |
Reported 13th consecutive quarter of increased revenue and profits| | | | Company officials expected the company to be listed among the Fortune 500 by year-end 1988| | | | Became one of Wall Street’s favorite stocks and recommended by many investment analysts| | | Jan-Oct 1988| | Competition for sales was intence; Heated price war dur to overcapacity throughout the industry| POSSIBLE SHAKE-OUT FORECASTED| | | Average cost of a megabyte memory had fallen approximately 25%| | | | Dataquest estimated world production capacity to be over 17M disk drives, but anticipated only 14M will be purchased = Intense Price Competition + Inventory Write-offs| | | | Changing Market Tastes: From 5 1/4-inch disk drives to the 3 1/2-inch drives| Both the market and developments in technology are ever-evolving.| | |
Dataquest expected orders to total nearly 10M 3 1/2-inch drives, 4M 5 1/4-inch drives| | | From all outward appearances, Miniscribe had made the turnaround and was on its way to becoming a billion-dollar company; Sales and Net Income increasing each quarter, market share was roughly 16% of the world’s disk-drive market; Dominated 3 1/2-inch disk-drive segment, accounted for 45% of Sales| Miniscribe dominated 3 1/2-inch-drive market| Miniscribe dominated the 3 1/2-inch disk drive market, which had expected orders to total 10M. Minsicribe’s share in the market accounted for 45% of their total sales. Meanwhile, the demand for the 4 1/4-inch drives was declining. | | |
Rapid Technological Change exerted considerable pressure on company on a company to turn inventory as quicky as possible.| REFER TO EXHIBIT 4: Efficiency ratios were declining from Q1 to Q3. Players were having difficulties. | | | Recent market entrants utlized modified design that resulted in lower production costs| Competition also takes into consideration production costs. Players can take a chunk out of the market, but this does not necessarily translate to profitability. | | | Paula learned that established firms were constantly looking for new markets for smaller disk drives – Forecasted growth in the US PC market would decline from 29% in 1987 to 17% in 1988 and 9% in 1989| Miniscribe’s commitment to R&D and its propensity to explore new segments/markets was somehow an assurance to investors that Miniscribe intends to stay competitive and sustain itself through the US PC market’s forecasted decline in growth. | Oct-88| Share price declined to a little over $8 as industry competition increased; Similar stock decreases also occurred for primary competitors (reflected in Exhibit 3)| | Miniscribe attributed decline of share prices to industry conditions – all players were facing the same setbacks as competition increased. In so doing, Miniscribe was claiming that the causes for decline was not internally caused. They were banking on their reputation as a credible corporation. | | Employed more than 8.350 people worldwide| | |
| Maintained production facilities in Colorado, Singapore (accounted for 80% Sales and was one of the largest and most sophisticated plants in the country) and Hong Kong (where printed circuit boards were made, expected segment to generate over $300M in 1989 sales) thereby making Miniscribe the largest electronic manufacturer| | If indeed Miniscribe was moving with the market trends accordingly, providing the right products to the market at the right place and time, then maybe it would be safe to recommend to retain Miniscribe in the “BUY” list. However, we do not have the information to support this claim if we rely on the readings alone. |