Investors Overreact to a Revolution-ary Contract

Investors Overreact to a Revolution-ary Contract

As you've probably heard by now, shares of LED lighting specialist Revolution Lighting popped by nearly 18% in Monday trading. But why?

One word: ignorance.

First, the facts
Let's start with what we know, and see if we can figure out whether investors were right to bid up the shares so high. According to the press release that Revolution put out Monday, the U.S. Navy's Military Sealift Command (MSC) contracted to buy 17,000 Seesmart 2- and 4-foot LED tube lamps. Further specifics on the lights were not provided. But Revolution has previously disclosed that its 15-watt LED tube lamp, for example, produces more than 1,700 lumens of light, and says it's "the industry's most efficient four-foot LED T8 lamp, utilizing the lowest wattage and generating the highest light output available." So far, so good.

We know, too, that MSC intends to install these lamps on the 14 newish Lewis and Clark-class Auxiliary Cargo and Ammunition Ships that General Dynamics built for it over the past 12 years, retrofitting these relatively new ships with even newer lighting technology.

Now, the math
Revolution didn't disclose the value of this contract. But judging from advertisements available on the Web, these lights appear to retail for anywhere from $50 to $70 apiece. Presumably, the Navy got a discount for buying in bulk. But even if it paid full freight, this still gives a maximum value on Revolution's contract of perhaps $1.2 million for 17,000 4-foot tube lamps.

That's certainly a sizable contract for a company like Revolution, which did only $20 million in sales over the past year. Yet consider: The 17.6% spike in the shares yesterday -- $0.50 per share -- added not $1.2 million, but rather $40.8 million to Revolution's market cap. This seems a bit excessive given our estimated value of the contract. When you consider further that Revolution is earning negative profit margins on its revenues, the logic of turning even a $1.2 million sales contract into a $40.8 million increase in market cap seems even more tenuous.

Granted, in time this Navy deal could get bigger. If MSC decides it likes the product, and expands its purchases to retrofit, say, its entire 110-ship fleet, this could result in orders eight times as large as Monday's 14-ship, 17,000-unit contract. But even if that happens ... we'd still be looking at a sales contract worth less than $10 million.

Turning news this small into an increase $40.8 million big is quite simply ridiculous. Investors got carried away, and I suspect they'll rue the day.

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Fool contributor Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway and owns shares of Berkshire Hathaway and General Dynamics. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published