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Competitive Advantage: Small and Micro cap series #2

by | Aug 17, 2016

1. ClearOne, Incorporated (CLRO, M.Cap: $98 million): Huge market share, Brand & Deep sales network

The company designs, develops and sells conferencing, collaboration, streaming and digital signage solutions for audio/voice and visual communications.

Huge market share: The Company occupies the number one global market share position, with nearly 50% market share in the professional audio conferencing market for its products used by large businesses and organizations such as enterprise, healthcare, education and distance learning, government, legal and finance. The company started citing market share information from the FY ended June 30, 2009. Since then, the company’s market share has not declined below fifty percent.

Brand: The Company is developing high-end, professional conferencing products since 1991 and has established strong brand recognition for these products worldwide.

Deep sales network: In 2015, the company sold its products directly to approximately 461 distributors and direct resellers in nearly 70 countries worldwide.

2. KMG Chemicals, Inc. (KMG, M.Cap: $322 million): Barrier to entry, Switching cost

(i) Wood treating chemicals

Penta is used primarily to treat electric, telephone and other utility poles, to protect them from insect damage and decay.

Sole manufacturer of Penta in North America: KMG is the only manufacturer of pentachlorophenol for the industrial wood preservation market.

Track record:  The Company enjoys a 60-year plus track record of environmental safety.  Penta-treated poles can last more than 50 years.

Barriers to entry: Wood treating chemicals must be registered prior to sale under United States law. As a condition to registration, any company wishing to manufacture and sell these products must provide substantial scientific research and testing data regarding the chemistry and toxicology of the products to the US Environmental Protection Agency (EPA). This data must be generated by the applicant, or the applicant must purchase access to the information from other data providers. The company believes that the cost of satisfying the data submission requirement serves as an impediment to the entry of new competitors, particularly those with lesser financial resources.

(ii) Electronics chemicals

The company sells high purity and ultra purity wet process chemicals primarily to the semiconductor industry.  These electronics chemicals are used to clean and etch silicon wafers in the production of semiconductors.

Market share: KCM acquired HPPC business from Air Products in the year December 2007.  At the time of acquisition, the company enjoyed 40% market share in the US and 20% in Europe. Currently, the company does not spell out its market share. Nevertheless, it notes that it has the “largest market share” and enjoys “limited competition” and “high barriers to entry”.

Switching cost: Generally, customers demand that each of their suppliers and each product used to make their semiconductors go through a rigorous qualification process. Once a customer has qualified one or more suppliers and their products for one of its fabrication facilities, there is often reluctance to switch to suppliers who are not qualified.

3. Lannett Company, Inc. (LCI, M.Cap: $1.1 billion): High barrier to entry

The company develops, manufactures, markets and distributes generic versions of branded pharmaceutical products.

Supplier and Distributor of narcotics and controlled drugs

In July 2008, the US Drug Enforcement Administration (DEA) granted the company’s subsidiary, Cody Laboratories, Inc. (Cody Labs), a license to directly import concentrated poppy straw for conversion into opioid-based active pharmaceutical ingredients (APIs) for use in various dosage forms for pain management.  This license, along with Cody Labs’ expertise in API development and manufacture allows the company to perform in a market with high barriers to entry, no foreign competition, and limited domestic competition.  Because of this vertical integration, the company has direct control of its supply and can avoid increased costs associated with buying APIs from third-party manufacturers, thereby achieving higher margins.

High barrier to entry

Narcotics, which are classified by the DEA as “controlled drugs”, are subject to a rigorous regulatory compliance regimen.

Supporting slides for KMG Chemicals

Supporting slide for Lannett Company

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