valuation/speculation Here are a few numbers that may be of...

valuation/speculation Here are a few numbers that may be of interest:

QRSH presently has 169mill ordinary shares on issue.

The company has also issued 21.8 mill options exercisable at 20c before January 12, 2005.

If the SP rises to around 25c, there is a high likelihood that all of these options will soon be exercised.

And the company is soon to issue 25 mill new shares (probably at around 20c).

This means that in a few months there is a high likelihood that QRSH will have 215.8 million shares on issue.

Assuming a 25c SP, this gives QRSH a market cap of $54million (implying a valuation of QRS Limited at $87million).

A notable defect in the Aegis valuation is that it does not anticipate the recently announced capital raising (or further capital raisings), nor does it take into account the dilutive effects of the 20c options being exercised. However, I think the Aegis profit forecast is as realistic as we could probably hope for at the present time. Thus, if we assume that the Aegis forecast of FY05 NPAT of $5.4mill is in the ballpark, we could expect FY05 eps to be around 2.5cps (assuming 215.8 million shares on issue). This means that at 25c QRS is trading at 10 times Aegis’ projected FY05 earnings.

On this basis, and taking into account forecasting risks, QRS is probably not as cheap as many of the posters on this board seem to be assuming.

In valuing QRSH, here are some other points to keep in mind:
According to KR, the bulk of QRS’ revenue in the foreseeable future (2-3 years) will come from receiving a one-off US$10k royalty payment for each sold machine that QRS’ technology is implemented in. QRS’ technology is being implemented in two ways. First, by being retrofitted onto existing x-ray/CT machines (primarily those manufactured by L-3 and Rapiscan) and second, by being utilised in next-generation CT-QR scanners that all three of QRS’ licensees are presently developing independently. If the TSA formally certifies the new CT-QR scanners (which I expect it will do before the end of CY04) there is a high likelihood that around 100-150 of these units will be sold to the TSA (or US airports) each year for the next few years. (Financial considerations and constant technological advancement limit how many EDS machines the TSA will purchase in a given FY). In 06, it is likely that European and Asian sales of these new CT-QR machines will kick in. However, in the foreseeable future I’m not expecting world-wide sales of these new machines to exceed 300 units annually (150 US + 150 rest of world). Thus, from new scanners, QRS is presently looking at receiving relatively small annual revenue (between US$1-3mill, assuming US$10k royalty payment). New products (QR wands, shoe scanners, train EDS etc), or a Smiths-Heimann licensing deal will change this equation. However, (1) commercial sales of these new products from QRS’ licensing partners are unlikely for at least 2-3 years, and (2), as each month passes a Smiths-Heimmann licensing deal is, unfortunately, looking less likely. SH is the market leader in EDS with a 25% market share. There is still time for SH to sign a licensing deal with QRS, but if SH hasn’t signed by the end of CY04, then I’d assume that SH intends to maintain/increase its market share with alterative technology platforms (such as Terahertz technology).

My point here is that the key profit driver for QRS in the foreseeable future (2 years) is likely to be the retrofit market which is defined by the already installed scanners manufactured by QRS’ 3 licensees (but mainly L-3 and Rapiscan). This is certainly the market that KR has been emphasising in his presentations to the media. The problem with pinning profit projections on this retrofit market is that it is very difficult to predict how extensive the retrofitting will be. On the one hand, there is a small (but not insignificant) risk that the retrofitting programme will not be implemented at all, due to economic or technological concerns. And even if retrofitting is technologically viable, economic criteria may necessitate that it be small scale, at least at the outset (perhaps only a few hundred units). On the other hand, the key advantage of QR technology at the present time is that it is thought to be the most reliable detector of plastic explosives (conventional X-ray or CT can’t detect plastic explosives — although S.Heinmann’s Terahertz technology can). And if the TSA/department of homeland security/European/Asian authorities give the plastic explosive threat high enough priority, then the retrofit programme could be conducted on a large scale from the outset. Indeed, it could be anywhere from 1k to 10k+ units per year over the next 2-3 years given that L-3 and Rapiscan presently have 28k EDS installed world wide.

If only a few hundred units are retrofitted over the next few years, QRS is looking at annual revenues over this period, including revenue from new machines and consultancy, somewhere in the order of $5million (= approximately $1.5m NPAT). On this basis QRS already looks over priced. If 1275 machines are retrofitted in FY05 and 2175 are retrofitted in 06/07 (Aegis’ assumption), then QRSH is probably fully valued at around 30-35c (taking into account dilution from the exercised options/new share issues). However, if the retrofit reaches 10k+ units over the next few years, then QRS could pull in $100mil+ in revenue over this period and Jerry’s $1+ valuation doesn’t look absurd.

However, even with this most optimistic (and somewhat unrealistic) scenario QRS does not have true ‘blue sky’ potential because we all know that the retrofit market will be gone in around 3 years.

In my view, the main explanation as to why QRS’ management team has such a small stake in the company is not that they doubt that the technology will be implemented, but that they are not (yet) confident that the retrofit programme will be undertaken on a scale large enough to generate significant profits.

As I’ve mentioned in earlier posts, there is also a risk of significant delays in the implementation of QRS’ technology. ‘Mum and dad’ shareholders should keep in mind that if QRS’ SP is trading above 20c then most shareholders at present are sitting on substantial profits. Thus, if large investors (including those that have recently exercised their 20c options) get the sense that there will be a delay in the roll out of the new QR products (= delay in QRS receiving licensing revenue), there will be a strong incentive to take profits by dumping shares (as they have done on previous occasions). Furthermore, judging by the SP movement on July 15-16, certain brokers/investors seem to have access to market sensitive information before everybody else. Thus, just as the buying on July 15-16 anticipated the China MOU, there is a good chance that any large volume selling that takes place without an announcement will anticipate a delay or a TSA test failure, etc. (Incidentally, it is my guess that the false July 16 rumour concerning the Mc. Douglas licensing deal was fed to the media by the parties doing the buying on July 15-16 so as to provide a ‘public’ reason (i.e. cover) for them to lift their stake).

I’ll discuss the ability of QRS to defend its patent portfolio in a later post.

I continue to rate QRS a speculative buy. An announcement regarding the TSA tests could come any day, and there is no telling how high ‘irrational exuberance’ could send this stock above sensible valuations. But I think other small-cap tech stocks like Ambri (ABI) ultimately look more attractive than QRS over the long term. ABI is a bio-nano play that IMO is substantially undervalued, cashed-up, well managed, and set for a run.