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Archive for August, 2009

In The growth illusion, an article appearing in the most recent Buttonwood’s notebook column of The Economist, Buttonwood argues that valuation, rather than economic growth, determines investment returns at the country level. In support of this thesis, Buttonwood highlights research undertaken by Elroy Dimson, Paul Marsh and Mike Staunton from the London Business School, which suggests that chasing growth economies is akin to chasing growth stocks, and generates similarly disappointing results. Buttonwood explains Dimson, Marsh and Staunton’s findings thus:

Over the 17 countries they studied, going back to 1900, there was actually a negative correlation between investment returns and growth in GDP per capita, the best measure of how rich people are getting. In a second test, they took the five-year growth rates of the economies and divided them into quintiles. The quintle of countries with the highest growth rate over the previous five years, produced average returns over the following year of 6%; those in the slowest-growing quintile produced returns of 12%. In a third test, they looked at the countries and found no statistical link between one year’s GDP growth rate and the next year’s investment returns.

Buttonwood posits several possible explanations for the phenomenon:

One likely explanation is that growth countries are like growth stocks; their potential is recognised and the price of their equities is bid up to stratospheric levels. The second is that a stockmarket does not precisely represent a country’s economy – it excludes unquoted companies and includes the foreign subsidiaries of domestic businesses. The third factor may be that growth is siphoned off by insiders – executives and the like – at the expense of shareholders.

William J. Bernstein discussed the phenomenon on his Efficient Frontier website in a 2006 article, Thick as a brick, in which he wrote:

In even simpler terms, just as growth stocks have lower returns than value stocks, so do growth nations have lower returns than value nations—and they similarly get overbought by the rubes.

Buttonwood discusses other research supporting Dimson, Marsh and Staunton’s findings:

Paul Marson, the chief investment officer of Lombard Odier, has extended this research to emerging markets. He found no correlation between GDP growth and stockmarket returns in developing countries over the period 1976-2005. A classic example is China; average nominal GDP growth since 1993 has been 15.6%, the compound stockmarket return over the same period has been minus 3.3%. In stodgy old Britain, nominal GDP growth has averaged just 4.9%, but investment returns have been 6.1% per annum, more than nine percentage points ahead of booming China.

Buttonwood concludes that higher valuations – determined on an earnings, rather than asset basis – lead to lower returns:

What does work? Over the long run (but not the short), it is valuation; the higher the starting price-earnings ratio when you buy a market, the lower the return over the next 10 years. That is why buying shares back in 1999 and 2000 has provided to be such a bad deal.

It raises an interesting question for us: Can relative price-to-asset values be used to determine which countries are likely to provide the best investment returns? If anyone is aware of such research, please leave a comment or contact us at greenbackd [at] gmail [dot] com.

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On Wednesday we called for guest posts on Greenbackd-style stocks. Our first guest post is from Wes Gray on CombiMatrix Corporation (NASDAQ:CBMX). Wes is a former Marine who, along with several partners, launched his maiden hedge fund, “Empirical Search Strategies” a year ago. He’s also a PhD candidate at the University of Chicago Booth School of Business, helps to run the Empirical Finance Research Blog website and has written a book, Embedded: A Marine Corps Adviser Inside the Iraqi Army, which you can purchase from Amazon. Phew. Here’s Wes’s idea:

There are a number of undervalued micro cap companies in this market, but not all values are created equal. Combimatrix (Symbol: CBMX) is a small biotech company that is tremendously undervalued by the market and has catalyst in place to realize its intrinsic value in the near term (~6months or less). Management is smart, downside is limited, and upside is huge( 100-200%+). There’s a lot to like at the current stock price.

Valuation

a. Cash

The company doesn’t appear to even remotely be a net-net by glancing at the balance sheet, however, closer inspection of the company’s contingent claims suggest otherwise. In 2005 the company won a lawsuit against National Union Fire Insurance relating to its director’s and officers’ insurance policy and was awarded a $32.1 million judgment by the US District Court. It was later awarded an additional $3.6 million by the court for attorneys’ fees and has continued to earn interest since this time.

National Union appealed, at which point the court required it to post an appellate bond of $39.2 million with the court. This means that the creditworthiness of National Union is not an issue and the only thing standing between CombiMatrix and the current value of the judgment is the Circuit Court. It appears very unlikely that the ruling will be overturned based on our legal due diligence: the decision was a bench verdict by a federal judge, and there were $0 dollars in punitive damages so the appeal theory is very weak. All briefs have been submitted to the court by both parties and only the oral hearing remains, meaning that a disbursement of the funds could happen soon. A decision is expected to be finalized by Q4 2009.

The $36mm lawsuit money and $10mm supplement represent $46mm. After the 20% lawyer fee we are left with ~30mm plus the $10mm supplemental (which we would likely do a settlement for 7mm to expediate process). Add back the $11mm cash balance on June 30, 2009 and the company is sitting on nearly $6.4 in cash per share (based on 7.5mm outstanding).

If we assume $3mm in cash burn and $12mm in liabilities (convert debt+misc liabilities+liquidation costs) at December 31, 2009, we are still left with a cash balance of ~$4.4mm per share ($33mm/7.5mm s/o).

b. CMDX laboratory (creates diagnostic products)

We visited the lab facilities at the beginning of August 2009 and were highly impressed (Robert Embree rembree@cmdiagnostics.com is the director of operations and is happy to give shareholder tours). The lab churns out a variety of diagnostics, but its primary value is in the top 4 tests (they have 11 tests in total): Prenatal/PostnatalScan, Her2Scan, HemeScan, and ProstateScan. These tests alone are easily worth more than the current market cap of the company (See the Benchmark April 2, 2009 research report for details on valuation/DCF, etc.). The lab in its entirety is hard to value exactly, but various estimates from the lab director, CEO, DCF analysis, and industry insiders put it north of $150-$200mm in the current market environment. To back this claim, just recently EXAS sold the IP for an unfinished test that is similar to the CBMX PP test for $18.5mm in cash and our test is better!

However, let’s be ultra conservative and say they fire sale it for $50mm (While at the lab I collected estimates on the resale value of the equipment in the lab and estimated the actual property inside to be worth $10mm at a minimum).

c. CCA

This is where things get really interesting. The latest technology from Combimatrix blows our minds – they call it the comprehensive cancer screening test (CCA). To put it in non-mad-scientist terms, here is how we would explain it: the test takes a drop of blood and puts it on a microchip. The microchip then detects if you have a certain DNA sequences that can determine if you have a variety of cancers. With obvious benefits to just about everyone, the market potential for such a product is enormous. Here is a presentation on the CCA and another (.pdf).

The projected launch for CCA continues to be mid-2010 and management disclosed that it is evaluating technology that could accelerate launch to as soon as Q1, 2010. CombiMatrix intends to complete CCA study protocols in the current quarter and to complete CCA studies in the first half of next year in time to support product launch. Larger clinical studies are anticipated after launch. We estimate that the CCA’s total addressable market could be up to $12-$15 billion at $250- $300 per test. Estimated the value of the CCA asset is difficult, but the potential is absolutely mind-blowing and the test would revolutionize medicine. Certainly not worth 0, but potentially worth 100’s of millions, if not 1 billion if things continue on the current track.

d. Leuchemix

CMBX also owns a 1/3 stake in a company called Leuchemix, which is developing a leukemia drug. Recent test results indicate the drug is both effective and well tolerated by patients. Here is a summary of multiple conversations we have had with the CEO of Combimatrix on the value of Leuchemix: Assuming phase 1 is completed and looks good, and Phase II is completed and looks good also (hopefully by first half next year), then CBMX will partner the drug with a big pharma company to support the phase 3 costs. The value of the compound will be dependent on the data, which will directly correlate with the size and structure of the partnership. In the past 5 years or so, there have been two or three deals with pharma and biotech companies that have been anywhere from 500 MM to 2 Billion dollars. These deals are usually structured as some money upfront, money to support the trial, and then money to be paid upon achievement of milestones and then royalties. With a drug, there is always a chance of failure, despite what the previous data looks like. However, the phase 1 data looks good so far, and if phase 2 looks good as well, the valuation will be driven by how good. If it looks great, then CBMX can easily achieve the several hundred million dollar valuation. If it looks bad, then it could be worth nothing. And it could be anywhere in between. When Leuchemix does 40 patients, and all 40 respond, then the sky is the limit on valuation. If none respond, then it’s zero. If 10% respond, then it might be worth 20 million, etc. If half respond, then it would be worth a few hundred million.

The bottom line is that most drugs don’t make it. And there have been many failures in leukemia. The research will cost money to do phase 3 and that money will come from a partner once Leuchemix has good phase 2 data. So CBMX needs to finish the phase 1 and show good phase 2. In its current stage, the entire thing is worth $15mm in this environment where risk-taking is so low for early-stage projects.

e. Government contracts/misc.

The company has other products as well. One is the Influenza Detection system, which works with technology similar to that of the cancer-screening tests. This product line got a big boost with the outbreak of the H1N1 Swine Flu, which the system is able to detect. When the swine flu broke out earlier this year, the FDA issued the Emergency Use Authorization which approved two tests developed by other companies for immediate use to detect the H1N1 strain. CombiMatrix’s flu detection system is far more complex, accurate and comprehensive, and thus also more expensive. This makes it more appropriate in research settings, where it has already been used. But if the swine flu gets really bad (as CEO Amit Kumar describes it, “more pathogenic and communicable”) then this cost will not be as important and CombiMatrix’s test will likely be adopted.

In early April the Ontario Agency for Health Protection and Promotion verified CombiMatrix’s Influenza-Detection system. Ultimately, these tests may help guard against H5N1 bird flu outbreaks. As public health ministries become accustomed to CombiMatrix’s technology, there is a possibility that CBMX could win a large contract anywhere from $10m to $100m could be awarded to CombiMatrix based on an average cost of the CBMX’s ‘in-house’ oligo array automated system, which costs around $200-300k per unit plus additional fees for customizable chips. Governments may want to use this platform for military use or civilian outbreaks and so the size of any potential contract is highly variable. Regardless, Canadian validation is a step towards drawing investment from more government agencies. Already, China has expressed some interest and Canada has been interested since its outbreak of severe acute respiratory syndrome (SARS) in 2003. Additionally, in March 2009, NASA awarded CombiMatrix $858,000 from NASA over three years for the Company’s semiconductor microarray that can be used in automated genetic analyses suitable for use in satellites. Later this year, the Company plans to launch a cell phone-sized array reader that can monitor genetic changes to bacteria as researchers circle the Earth. Beyond government contracts, academia and other research laboratories are potential buyers of CombiMatrix’s platform technology that enables ‘in-house’ customizable array services. Sales to these institutions represented about one-third of total revenue on average.

Summary:

$4.4/s in “cash liquidation value”

+~$6/s CMDX lab ( $50mm conservative value, potentially worth $150mm+)

+~$4/s CCA technology ($30mm ultra conservative value to immediate buyer with huge option value)

+~$1/s 1/3 Leuchemix (conservatively worth $5mm in current state, but huge option value)

+~$1/s govt contracts/misc (worth $5mm+ based on comparable p/s ratios in the space)

=ultra conservative $16.4/s value versus current stock price of $6/s

Catalyst

1. CEO buying

Amit Kumar has purchased over 10,000 shares on the open market since November 2008 (6,000+ shares in August) and has reiterated numerous times in conference calls and private phone calls that he believes the equity is “grossly undervalued.”

2. Short interest (representing over 5% of s/o and over 10x average daily trading volume) may come under pressure as asset sales are announced.

3. Bidding process is about to begin.

Last week, the company announced that it has engaged multiple investment bankers to aid the company in an “effort to unlock shareholder value.” This could mean, according to CEO Amit Kumar, the sale of all or a portion of the business. This is the catalyst the stock needs to unlock the value in its underlying assets. Recently, comparable companies have successfully monetized their assets in the diagnostics space. For instance LabCorp (NYSE: LH) offered $4.55 per share of Monogram Biosciences (NASDAQ: MGRM) to acquire the company in July, for a total valuation of Monogram of $155 million (including the assumption of debt).

It’s hard to say how the market will value the various assets owned by CBMX, but one can be fairly certain that purchasing the stock around $6 creates a huge margin of safety for the patient investor.

[Full Disclosure: We have a holding in CBMX. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Although we closed our position in Avigen Inc (NASDAQ:AVGN) earlier this week, we’re keeping a watching brief on the stock. AVGN has now filed with the SEC the terms of the deal with MediciNova Inc (NASDAQ:MNOV), and they’re not as bad as the earlier report seemed to suggest. The deal has, however, attracted the ire of The Pennsylvania Funds, an AVGN shareholder, who has filed a class action lawsuit on behalf of all AVGN stockholders. The stock closed yesterday at $1.28, about $0.01 under our exit price. The terms of deal provide some downside protection and some upside optionality, and so are worth considering in some more detail, although probably not enough of either to persuade us to re-enter the stock. If the lawsuit gains traction and pushes the stock price down, however, AVGN might become attractive again.

About AVGN

We started following AVGN in December last year (see archived posts here) because it was a net cash stock and specialist biotechnology investor Biotechnology Value Fund (BVF) was pushing it to liquidate and return its cash to shareholders. Despite BVF’s failure to remove the board, we continued to maintain our position in AVGN because BVF won a number of important concessions from the board that made AVGN a much more attractive stock than it was when we started following it. We continuted to hold on when AVGN announced that it was back in negotiations with MediciNova, Inc, but closed the position for a 98.5% gain when the initial terms of the deal were announced.

The terms of the deal

The downside protection

Under the terms of the merger agreement AVGN shareholders will have the right to elect to receive an amount currently estimated by AVGN’s board at $1.24 per share in either cash or secured convertible notes to be issued by MNOV. Approximately $1.19 of the consideration will be paid at the closing, and approximately $0.05 will be paid at June 30, 2010. Both payments are subject to certain potential adjustments. The first payment is subject to adjustment based on activities related to the liquidation or sale of certain assets of AVGN in connection with the winding down of its operations prior to closing. The second payment is subject to upward adjustment based on savings in estimated expenses through closing and receipt of certain payments post-closing as well as downward adjustment in the event that closing liabilities exceed estimated liabilities through closing.

The upside optionality

The secured convertible notes will be convertible on the final business day of each month into shares of MNOV common stock at a conversion price of $6.80 per share, which conversion price is based on the volume-weighted average price of MNOV’s common stock as quoted on Nasdaq and the Osaka Securities Exchange over the 20 trading days prior to signing of the merger agreement. The convertible notes will mature on the 18-month anniversary of the closing of the merger, and the indenture governing the notes will include customary events of default and anti-dilution adjustments. Note that the last time MNOV traded above $6.80 was two years ago in August 2007.

The joint press release announcing the terms of the deal is set out below:

MediciNova and Avigen Enter Into Definitive Agreement for Business Combination

SAN DIEGO, Calif., and ALAMEDA, Calif., August 21, 2009 — MediciNova, Inc., a biopharmaceutical company that is publicly traded on the Nasdaq Global Market (Nasdaq:MNOV) and the Hercules Market of the Osaka Securities Exchange (Code Number:4875) and Avigen, Inc. (Nasdaq:AVGN), a biopharmaceutical company, today announced that they have entered into a definitive merger agreement pursuant to which MediciNova’s wholly-owned subsidiary will merge with and into Avigen. Completion of the transaction will permit the combination of the companies’ broad neurological clinical development programs based on ibudilast (Avigen’s AV-411 and MediciNova’s MN-166).

Under the terms of the merger agreement, which has been approved by both companies’ boards of directors, Avigen shareholders will have the right to elect to receive an amount currently estimated at approximately $1.24 per share in either cash or secured convertible notes to be issued by MediciNova. Approximately $1.19 of this consideration will be paid at the closing, and approximately $0.05 will be paid at June 30, 2010. As set forth in the merger agreement, both payments are subject to certain potential adjustments. The first payment is subject to adjustment based on activities related to the liquidation or sale of certain assets of Avigen in connection with the winding down of its operations prior to closing. The second payment is subject to upward adjustment based on savings in estimated expenses through closing and receipt of certain payments post-closing as well as downward adjustment in the event that closing liabilities exceed estimated liabilities through closing.

The secured convertible notes will be convertible on the final business day of each month into shares of MediciNova common stock at a conversion price of $6.80 per share, which conversion price is based on the volume-weighted average price of MediciNova’s common stock as quoted on Nasdaq and the Osaka Securities Exchange over the 20 trading days prior to signing of the merger agreement. The convertible notes will mature on the 18-month anniversary of the closing of the merger, and the indenture governing the notes will include customary events of default and anti-dilution adjustments.

In addition, Avigen’s stockholders will be entitled to one Contingent Payment Right (“CPR”) that will entitle holders under certain circumstances to a pro rata portion of one or more of the following: (1) in the event the first milestone payment of $6.0 million, or approximately $0.20 per share, under Avigen’s 2005 assignment agreement with Genzyme Corporation (“Genzyme Agreement”) is achieved in the 20 months following closing, a cash payment of the proceeds (to the extent such cash is received by MediciNova in the 20 months following closing); (2) in the event the Parkinson’s product reverts to MediciNova under the Genzyme Agreement and is subsequently sold, licensed or otherwise transferred, 50% of the proceeds received in cash in the 20 months following closing; and (3) the amount of money remaining in the plan trust established under Avigen’s management transition plan following termination of such trust. In each case, the payments will be net of any related out-of-pocket costs, damages, fines, penalties and expenses incurred by MediciNova. The CPRs will not be transferable except in limited circumstances.

Yuichi Iwaki, M.D., Ph.D., MediciNova’s President and Chief Executive Officer, said, “We are excited about combining Avigen with MediciNova and believe that it presents a unique opportunity for shareholders of both companies, most notably, the ability to more fully take advantage of the opportunities that the ibudilast compound and analogs provide in a variety of indications and markets.”

“We believe the transaction reduces many of the uncertainties involved with dissolution and is in the best interests of our shareholders,” commented Andrew Sauter, Avigen’s Chief Executive Officer, President and Chief Financial Officer. “In addition, we believe that combining the two companies’ ibudilast programs will enhance the global development potential for the compound that could benefit patients with a range of neurological indications.”

The transaction is expected to close in the fourth quarter of 2009 and is subject to approval of Avigen’s stockholders and approval of MediciNova’s stockholders as well as other customary closing conditions. In addition, the closing is conditioned on the receipt of certain releases from Avigen’s directors (other than John K.A. Prendergast), Kenneth Chahine, Kirk Johnson and Andrew A. Sauter.

RBC Capital Markets Corporation is acting as financial advisor to Avigen and Cooley Godward Kronish LLP is serving as its legal counsel. Ladenburg Thalmann & Co. Inc. (NYSE Amex: LTS) is acting as financial advisor to MediciNova, Euclidean Life Science Advisors is acting as its business advisor and Dechert LLP is serving as its legal counsel.

The AVGN press release disclosing the law suit is set out below:

On August 25, 2009, The Pennsylvania Funds filed a class action lawsuit in the Superior Court of the State of California, County of Alameda, purportedly on behalf of the stockholders of Avigen, Inc., against Avigen and its directors, alleging that Avigen’s directors breached their fiduciary duties to the stockholders of Avigen in connection with the proposed acquisition of Avigen by MediciNova, Inc. The complaint seeks to enjoin the defendants from completing the acquisition as currently contemplated.

Avigen and its directors intend to take all appropriate actions to defend the suit.

It is possible that additional similar complaints may be filed in the future. If this does occur, Avigen does not intend to announce the filing of any similar complaints unless they contain allegations that are substantially distinct from those made in the pending action.

Conclusion

With the terms of the deal announced by AVGN, we’re still happy to be out of the stock. The downside protection is subject to various adjustments, and the upside is wholly dependent on the performance of MNOV’s stock over $6.80, which is higher than the stock has traded since 2007. That said, it’s worth watching to the see the effect of the class action on the stock price, because there is a price at which the stock again becomes attractive.

Hat tip GR.

[Full Disclosure: We do not have a holding in AVGN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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We’ve received some great investment ideas on this blog from our readers, and it seems a shame that they remain hidden in the comments of other posts (See, for example, Shake&Bake’s take on LDIS or Sop81_1′s analysis of EDCI). To that end, we’re extending an open invitation to anyone who wishes to submit a post for publication. The only requirement is that it be within the remit of Greenbackd, which is say that it is an undervalued asset situation with a catalyst. Email your idea to greenbackd [at] gmail [dot] com.

We have our first guest post for Friday from Wes Gray. We hope it’s the first of many.

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MRV Communications Inc  (OTC:MRVC) is an activist play with Value Investors for Change – who recently filed proxy documents in relation to VXGN – seeking to replace the “current, ineffective board of directors” with a new board of “highly qualified, independent directors committed to realizing for all MRVC stockholders the fullest potential of their investments.” Value Investors for Change detail a litany of problems with this stock in the preliminary proxy filing, which range from a simple failure to file financial statements or hold an annual meeting to the mishandling of an acquisition and an options dating scandal. What’s the attraction to the stock? Two things:

1. As at the last filing date, for the period ended March 31, 2008, MRVC’s (unaudited) NCAV was around $113.9M or $0.72 per share, which is yesterday’s closing price. Note that the liquidation value is likely negligible and the financial statements are more than a year out of date (which makes any valuation problematic). One positive is the revenue: the company has annualized revenue of around $500M. A small improvement in margins could result in a big improvement in earnings.

2. Value Investors for Change believes the company has a “valuable franchise and a strong market position” and we like their approach, described in the preliminary proxy documents thus:

The participants in this solicitation (collectively, “Value Investors for Change”) are investors who seek to encourage companies to create, preserve and enhance long-term value for their stockholders, the true owners of America’s public companies. We have developed a sophisticated screening process that we use to identify public companies that we believe (i) are undervalued, (ii) are not adequately serving the interests of their stockholders and (iii) require a new board of directors, so that, with the encouragement of stockholders such as you, we can begin implementing reforms ourselves with the goal of increasing stockholder value.

We’re adding MRVC to our Special Situations portfolio at its $0.72 close yesterday.

About MRVC

From the last 10Q:

MRV Communications is a supplier of communications equipment and services to carriers, governments and enterprise customers, worldwide. We are also a supplier of optical components, primarily through our wholly owned subsidiaries: Source Photonics and Fiberxon. We conduct our business along three principal segments: (1) the network equipment group, (2) the network integration group and (3) the optical components group. Our network equipment group provides communications equipment that facilitates access, transport, aggregation and management of voice, data and video traffic in networks, data centers and laboratories used by telecommunications service providers, cable operators, enterprise customers and governments worldwide. Our network integration group operates primarily in Italy, France, Switzerland and Scandinavia, servicing Tier One carriers, regional carriers, large enterprises, and government institutions. We provide network system design, integration and distribution services that include products manufactured by third-party vendors, as well as products developed and manufactured by the network equipment group. Our optical components group designs, manufactures and sells optical communications products used in telecommunications systems and data communications networks. These products include passive optical network, or PON, subsystems, optical transceivers used in enterprise, access and metropolitan applications as well as other optical components, modules and subsystems. We market and sell our products worldwide, through a variety of channels, which include a dedicated direct sales force, manufacturers’ representatives, value-added-resellers, distributors and systems integrators.

In July 2007, we completed our acquisition of Fiberxon, a PRC-based supplier of transceivers for applications in metropolitan networks, access networks and passive optical networks, for approximately $131 million in cash and stock. Fiberxon is part of the Optical Components group, and its results of operations are included in our Consolidated Financial Statements from July 1, 2007.

The value proposition

The main problem with any analysis of MRVC is that the financial statements are more than a year out of date. As at the last filing, MRVC’s NCAV was around $113.9M or $0.72 per share. We believe that the liquidation value is likely neglible. We’ve set out the valuation below in the usual manner (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

MRVC SummaryAs at the last filing date, the company had quarterly revenue of $125M, which annualizes to around $500M. A small improvement in margins could result in a big improvement in earnings. Value Investors for Change seek to provide that improvement, which they describe in the preliminary proxy documents set out below.

The catalyst

From the preliminary proxy documents:

REASONS FOR THE SOLICITATION

Value Investors for Change believes that the Company has a valuable franchise and a strong market position. However, we believe this value has been masked and the Company’s potential remains unrealized due to the Board’s lack of effective oversight and appropriate corporate governance policies.

Our Nominees will provide new independent voices in the Company’s boardroom and they will seek to start the process of rebuilding stockholder value. Our Nominees are committed to fully implementing and embracing long overdue corporate governance reforms.

We do not believe the current directors serving on the Board are acting in the best interests of stockholders and are concerned that this Board will fail to take the steps we believe are necessary to preserve stockholder value.

Fate of the Company’s remaining cash balance

This Annual Meeting may be the only opportunity for stockholders to determine the fate of MRVC’s substantial remaining cash balance (this amount was $73.7 million as of June 30, 2009, including short-term investments, as per the Company’s press release attached as an exhibit to its Form 8-K filed on July 27, 2009). Actions and statements by the Company indicate that the existing management and Board are prepared to ignore the best interests of the Company’s stockholders. Indeed, their track record of negative operating cash flows over the past several years is reflective of the same. If the incumbent Board and management are not replaced at this Annual Meeting, stockholders may not only lose any hope of determining the fate of MRVC’s remaining cash reserves, but also will likely have their share value further eroded. If elected to the Board, none of our Nominees intend to accept any cash fees from the Company. The Funds’ only interest here is as a stockholder.

Deficient Corporate Governance Procedures; Recent Options Scandal

The Company continues to be embroiled in an options scandal. We believe the Board was in need of change even before the current scandal broke, but the options scandal has served to underscore the need for urgent reform.

According to a press release issued by the Company on June 5, 2008, beginning in the middle of 2006 through early 2007, MRVC conducted an informal review of its share-based award practices and concluded that there was no evidence that grant dates of options were designed to occur on dates with more favorable exercise prices (i.e., on dates with lower market prices). Given subsequent events, it appears though that this review, which lasted over six months, was inadequate and did not discover certain inappropriate practices which had taken place. During this lengthy investigation and after its completion, the Company filed numerous quarterly reports and an annual report on Form 10-K for the fiscal year ended December 31, 2007, certifying to the accuracy of those financial statements. Well after this investigation and after these filings, management then determined that the conclusions reached from the earlier review were incorrect with respect to certain options granted during the period from 2002 through the first quarter of 2004. The Board determined that the financial statements for the periods from 2002 to 2008 and the related reports of MRVC’s independent public accountants, earnings press releases, and similar communications previously issued by MRVC should not be relied upon as a consequence of the pending restatement of its historical financial statements. It has been over a year since the press release announcing this major problem for the Company was issued and yet no restatements of the Company’s financial statements have been filed.

As a result of these actions,

• the Company currently faces an inquiry by the Securities and Exchange Commission (the “Commission”);

• the Company has been unable to file its annual report on Form 10-K for the year ended December 31, 2008;

• the Company has been unable to file its quarterly reports on Form 10-Q for the periods ended June 30, 2008, September 20, 2008, March 31, 2009 and June 30, 2009;

• the Company has received 6 determination letters from NASDAQ informing the Company that it would be subject to delisting as a result of its failure to timely file its financial statements and, on June 17, 2009, NASDAQ suspended the listing of the Company’s common stock from the NASDAQ Stock Market as a result of the Company’s failure to file such financial statements;

• on August 19, 2009, the NASDAQ Stock Market announced that it will delist the Company’s common stock (NASDAQ will file a Form 25 with the Commission to complete the delisting which becomes effective ten days after the Form 25 is filed); and

• the Company faces various lawsuits related to its stock option practices.

These option grants raise serious questions about the Board’s judgment and apparent disregard for the interests of stockholders. Such behavior raises significant doubts about the integrity of the Board.

Mishandling of the Acquisition of Fiberxon

On June 26, 2007, the Company amended an Agreement and Plan of Merger between affiliates of the Company and Fiberxon, Inc. that was initially entered into on January 26, 2007 (the “Merger Agreement”) to, among other things, remove as a condition precedent for the consummation of the merger that Fiberxon, Inc. deliver to MRVC its audited consolidated financial statements prior to the closing of the transaction. This amendment was unanimously approved by MRVC’s Board despite their knowledge that:

• there were allegations of financial and accounting irregularities that called into question the reliability of Fiberxon’s consolidated financial statements for its fiscal years ended December 31, 2004 and 2005 raising serious concerns regarding Fiberxon’s financial and reporting processes;

• in addition to the irregularities, Fiberxon’s independent auditors called into question the commitment of Fiberxon’s management to maintain reliable financial reporting systems, including accounting books and records, in conformity with accounting principles generally accepted in the United States and the People’s Republic of China;

• in the view of Fiberxon’s auditors, these matters also raised doubt on the ability of Fiberxon’s existing management to provide its auditors the written representations required under auditing standards generally accepted in the United States; and

• the suspension by the independent auditors of its audit of Fiberxon’s financial statements in June 2007 would likely have an adverse impact on the Company’s ability to obtain and file Fiberxon’s financial statement within the time allowed by, and in the form and content required by, the Commission’s rules thereby leading to:

• MRVC not being eligible to use the Commission’s short-form registration statement on Form S-3 to register the issuance of its securities; and

• the delisting of the Company’s common stock from the NASDAQ Stock Market and, as a result of the delisting, a default on the Company’s outstanding convertible notes.

Additionally, the Board was aware that if MRVC delayed filing with the Commission certain financial statements relating to the Fiberxon acquisition, as required by the Commission, this would put at risk the Company’s ability to use an effective registration statement to issue securities, thus handcuffing the Company’s ability to raise funds if it became necessary to do so. We believe this lack of regard that the Board showed for the stockholders of the Company highlights the incompetence of the Board and the management of the Company.

Failure to Hold an Annual Meeting

The Annual Meeting is the once-a-year event for all stockholders to voice their views and concerns. Despite the Company’s professed commitment to stockholder democracy and good corporate governance, the Company appears unable to take appropriate actions regarding governance.

On July 20, 2009, Spencer Capital Opportunity Fund, LP filed a lawsuit in Delaware pursuant to Section 211(c) of the Delaware General Corporation Law requesting that the Court of Chancery of the State of Delaware (the “Chancery Court”) order MRVC to hold its 2009 annual meeting of stockholders without delay and to grant other relief deemed appropriate by the Court. Under Delaware law, if a corporation fails to hold an annual meeting of stockholders or take action by written consent to elect directors for a period of 13 months, any stockholder may petition the Chancery Court to order that a meeting be held. MRVC has not held an annual meeting of stockholders since May 29, 2007 and accordingly has not met its obligations under Delaware law.

Pursuant to a Stipulated Order entered into in the Chancery Court dated August 7, 2009 (the “Order”), MRVC will hold its Annual Meeting on or before November 11, 2009. In the event that the Company’s Board or its outside auditor determines that the Company’s restatement of its financial statements is complete such that the Annual Meeting could be held at a date earlier than November 11, 2009, then the Company will hold the Annual Meeting not more than 40 days after this determination.

Damage to Company’s Credibility

It seems clear to us that the crucial issue of the credibility of the Company’s Board and management has been identified both outside and inside the Company. We believe MRVC is at a crossroads. The Company is beset by problems arising out of actions taken by management and overseen by the Board. Moreover, these issues have diverted the Board and management from attending to the successful operation of the business. In the face of these developments, the Company’s stock price meaningfully lags behind its peers. It is up to us, as MRVC’s stockholders, to send a clear and definite message to MRVC’s Board and management that meaningful change is needed. By voting for our Nominees, you will join us in sending that message to the current Board and help put MRVC back on the right course.

Dismal Share Price Performance

Last, but certainly not least, is MRVC’s ever-worsening stock price. Between January 1, 2005 and July 20, 2009, the date on which Spencer Capital Opportunity Fund, LP, filed a complaint requesting that the Chancery Court compel the Company to hold its Annual Meeting, MRVC’s stock price has fallen by 87.2%. We believe this is due to the perception of the investment community that this Board will destroy the Company’s remaining value.

An action plan to rebuild stockholder value is needed, and fast. Value Investors for Change proposes to take the following steps which we believe will return the Company to a positive track and serve the best interests of all of MRVC’s stockholders:

(1) Restore confidence in the Board and management by:

• appointing new independent, unbiased directors to the Board who are both expertly capable and determined to steer a new course for the Company; and

• instituting corporate governance reforms, including applying a pay for performance compensation plan for management.

(2) Create and implement a new corporate strategy by:

• assessing the Company’s competitive prospects and strategic options for growth and profitability and implementing a new corporate strategy; and

• enlisting the guidance of telecommunications industry executives to assist with this review and strategy.

(3) Resolve the outstanding accounting, legal and regulatory issues by:

• concluding the internal accounting review and taking appropriate steps to rectify this matter;

• coming into full compliance with the rules of the Commission; and

• engaging with plaintiffs in the various lawsuits against the Company to seek timely resolutions.

Value Investors for Change urges you to vote FOR the Funds’ proposal to elect our Nominees on the enclosed WHITE proxy card, thereby ending this disregard for stockholder interests. For too long, MRVC has operated without proper oversight by the Board and has hidden behind poor corporate governance policies that neither respect the interests of the Company’s stockholders nor provide meaningful Board accountability. Vote to elect a new slate of directors who are willing to stand up for the interests of all stockholders and work to maximize stockholder value.

Conclusion

MRVC is an activist play with Value Investors for Change. Two things attract us to the stock:

1. MRVC’s NCAV is around $113.9M or $0.72 per share, although we note that the liquidation value is likely negligible and the financial statements are more than a year out of date, which makes any valuation problematic. One positive is the revenue: the company has annualized revenue of around $500M. A small improvement in margins could result in a big improvement in earnings.

2. We like the approach of Value Investors for Change.

We’re adding MRVC to our Special Situations portfolio at its $0.72 close yesterday.

MRVC closed yesterday $0.72.

The S&P500 closed yesterday at 1,025.56.

[Full Disclosure: We do not have a holding in MRVC. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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MediciNova Inc. (NASDAQ:MNOV) will acquire Avigen Inc (NASDAQ:AVGN) for $1.24 per share in cash or secured convertible notes. While the stock is trading at a slight premium to the bid, we’re taking the opportunity to exit. AVGN closed Friday at $1.29, which means we’re up 98.5% on an absolute basis. The S&P500 was at 816.21 when we opened the position, and closed Friday at 1,026.13, which means we’re up 72.7% on a relative basis.

Post mortem

We started following AVGN in December last year (see archived posts here) because it was a net cash stock and specialist biotechnology investor Biotechnology Value Fund (BVF) was pushing it to liquidate and return its cash to shareholders. Despite BVF’s failure to remove the board, we continued to maintain our position in AVGN because BVF won a number of important concessions from the board that made AVGN a much more attractive stock than it was when we started following it. We continuted to hold on when AVGN announced that it was back in negotiations with MediciNova, Inc. The consideration for the deal was announced as AVGN’s “net cash liquidation value plus $3 million” and “a contingent payment right for a specific product program milestone payment associated with Avigen’s Assignment Agreement with Genzyme Corporation, potentially subject to certain adjustments.” That seems tono longer be the case. The deal announced Friday calls for a payment of around $1.19 a share when the deal closes, with approximately $0.05 per share to be paid on June 30, 2010. This is a disappointing deal. AVGN has been sold for its net cash liquidation value plus $3M from MediciNova. We held on because we believed that there was a reasonable chance that AVGN could yield more than its then $1.34 share price when the “contingent payment right” capturing the near term payments from Genzyme was taken into account. MNOV has not provided AVGN shareholders with any value for AVGN’s AV411 assets and program.

Here is the press release announcing the sale (via MarketWatch):

MediciNova To Acquire Avigen For $1.24 a Share

William L. Watts

MarketWatch Pulse

LONDON — Biopharmaceutical firm MediciNova Inc. will acquire Avigen Inc. for $1.24 a share in cash or secured convertible notes, under an agreement announced Friday by the biopharmaceutical firms. Under the deal, around $1.19 a share will be paid when the deal closes, with approximately 5 cents a share to be paid on June 30, 2010. The transaction is expected to close in the fourth quarter, pending the approval of Avigen and MediciNova stockholders and other considerations. The companies said the merger will allow them to combine their neurological clinical development programs based on ibudilast, an anti-inflammatory drug.

[Full Disclosure: We have a holding in AVGN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Spencer Capital has filed preliminary proxy documents to remove the board of VaxGen Inc (OTC:VXGN). In the documents, Spencer Capital, which leads a group of investors calling themselves “Value Investors for Change,” call out VXGN’s board on its “track record of failure and exorbitant cash compensation”:

VaxGen does not have any operations, other than preparing public reports. The Company has three employees, including the part-time principal executive officer and director, and four non-employee directors. Since the Company’s failed merger with Raven Biotechnologies, Inc. in March 2008, the Board has publicly disclosed that it would either pursue a strategic transaction or a series of strategic transactions or dissolve the Company. The Company has done neither. In the meantime, members of the Board have treated themselves to exorbitant cash compensation. Until July 2009, two non-employee members of the Board were paid over $300,000 per year in compensation. The principal executive officer will likely receive over $400,000 in cash compensation this year.

We’ve been following VXGN (see our post archive here) because it is trading at a substantial discount to its net cash position, has ended its cash-burning product development activities and is “seeking to maximize the value of its remaining assets through a strategic transaction or series of strategic transactions.” Management has said that, if the company is unable to identify and complete an alternate strategic transaction, it proposes to liquidate. One concern of ours has been a lawsuit against VXGN by its landlords, in which they sought $22.4M. That lawsuit was dismissed in May, so the path for VXGN to liquidate has now hopefully cleared. The board has, however, been dragging its feet on the liquidation. Given their relatively high compensation and almost non-existent shareholding, it’s not hard to see why.

VXGN has now also attracted the attention of BA Value Investors, which has disclosed an activist holding and called on VXGN to “act promptly to reduce the size of the board to three directors; reduce director compensation; change to a smaller audit firm; terminate the lease of its facilities; otherwise cut costs; make an immediate $10 million distribution to shareholders; make a subsequent distribution of substantially all the remaining cash after settling the lease termination; distribute any royalty income to shareholders; and explore ways to monetize the public company value of the Issuer and use of its net operating losses.”

VXGN is up 25.0% since we initiated the position. At its $0.60 close yesterday, it has a market capitalization of $19.9M. We last estimated the company’s liquidation value to be around $25.4M or $0.77 per share. VXGN has other potentially valuable assets, including a “state-of-the-art biopharmaceutical manufacturing facility with a 1,000-liter bioreactor that can be used to make cell culture or microbial biologic products” and rights to specified percentages of future net sales relating to its anthrax vaccine product candidate and related technology. The authors of a letter sent to the board on July 14 of this year ajudge VXGN’s liquidation value to be significantly higher at $2.12 per share:

Excluding the lease obligations, the net financial assets alone of $37.2 million equate to $1.12 per share. The EBS royalties (assuming a 6% royalty rate and a $500 million contract as contemplated by NIH/HHS and EBS) of $30 million and milestones of $6 million total $36 million of potential additional future value (based clearly on assumptions, none of which are assured), or $1.09 per share. Adding $1.12 and $1.09 equals $2.21 per share.

Spencer Capital’s proxy solicitation is a welcome relief, and, with any luck, we will see a liquidation of VXGN soon, either at the hands of the present board, or by Value Investors for Change.

The preliminary proxy statement sets out the Value Investors for Change group’s “Reasons for the solicition” thus:

Even though VaxGen does not have substantial operations, Value Investors for Change believes that the Company has valuable assets, consisting of cash and net operating loss carryforwards (“NOLs”). We believe these assets should be unlocked for the benefit of shareholders, rather than consumed over time by the current Board.

We do not believe the members of the current Board are acting in the best interests of stockholders. Since the Company’s failed merger with Raven Biotechnologies, Inc. in March 2008, the Board has publicly disclosed that it would either pursue a strategic transaction or a series of strategic transactions or dissolve the Company. The Company has done neither. Instead, the Board has overseen the consumption of a large portion of the Company’s assets while paying itself exorbitant compensation. In addition, the Board’s interests are not aligned with the stockholders, as displayed by their miniscule equity stake in the Company.

Consumption of Assets

Since discontinuing its operations, the Company has consumed a significant amount of assets. According to its most recent quarterly report on Form 10-Q, since June 30, 2008, the Company’s assets have decreased by $31.7 million, or 45%. Since December 31, 2008, the Company’s assets have decreased by over $3.5 million, or 8.4%.

In addition, the Company recorded $3.6 million in general and administrative expenses during the six month period ended June 30, 2009. Much of this expense consisted of cash compensation to the Board.

Exorbitant Board Compensation

Despite the relatively simple task of overseeing a shell company and conducting an ordinary sale process, the Board has paid itself inordinately high compensation. The table below describes the principal executive officer’s 2009 cash compensation and the director cash compensation scheme for the VaxGen Board, as described in the Company’s 2008 annual report on Form 10-K:

VXGN Board Compensation 1

(This table has been modified from the original to fit this space)

* Consists of $195,000 annual base salary for 25 hours per week employment and a $193,050 lump sum payment. The lump sum payment was approved by the Board in consideration for Mr. Panek’s agreement not to resign for “good reason” under his employment agreement.

** VaxGen announced in its quarterly report for the period ended June 30, 2009 that, effective September 1, 2009, it had disbanded the Strategic Transactions Committee and that, following its disbandment, Board members would no longer receive additional compensation for service thereon.

While it is difficult to envision the rationale for the high cash compensation awarded to the Chairman Kevin Reilly and Franklin Berger, the most excessive portion of the director compensation consisted of the payments to the non-employee members of the Strategic Transactions Committee. Beginning in May 2008, Board members Lori F. Rafield and Paul DeStefano received $20,000 per month and $15,000 per month, respectively, for service on the Strategic Transactions Committee, which was formed to identify, review and evaluate potential strategic transactions and alternatives. Within a few months, these directors increased their compensation to $32,000 and $27,000 per month, respectively. This compensation is extraordinarily excessive.

Insignificant Board Equity Ownership

The members of the Board hold very few shares of the Company’s common stock. Most of the Board’s beneficial ownership holdings consist of underwater stock options. The following table describes the stockholdings of the Board, as set forth in the 2008 annual report, excluding options.

VXGN Board Compensation 2This Board has failed to take the steps we believe are necessary to preserve and enhance stockholder value. We believe the actions taken by the Board indicate that they are more interested in acting in their own self-interest rather than in the best interests of stockholders.

Value Investors for Change urges you to vote FOR the Fund’s proposal to elect the Nominees on the enclosed WHITE proxy card, thereby ending this disregard for stockholder interests. Vote to elect a new slate of directors who are willing to stand up for the interests of all stockholders and work to maximize stockholder value.

The members of the Board hold very few shares of the Company’s common stock. Most of the Board’s beneficial ownership holdings consist of underwater stock options. The following table describes the stockholdings of the Board, as set forth in the 2008 annual report, excluding options.

Hat tip bellamyj and matt.jensen08.

[Full Disclosure:  We have a holding in VXGN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Axcelis Technologies Inc (NASDAQ:ACLS) has filed its 10Q for the period ended June 30, 2009.

We started following ACLS on January 8 this year (see our post archive here) because it is an undervalued asset play with an activist investor, Sterling Capital Management, holding 10.7% of its outstanding stock. ACLS has completed the sale of its 50% interest in SEN Corporation, its joint venture with Sumitomo Heavy Industries, Ltd. (SHI) to SHI for proceeds of $122.3 million. ACLS received around $35.9M in cash after applying $86.4M of the proceeds to meet obligations to the holders of the company’s 4.25% Convertible Senior Subordinated Notes, upon which ACLS defaulted in January. We last estimated ACLS’s liquidation value at around $117.8M or $1.14 per share. Following our review of the 10Q, we’ve reduced our estimate to $113.6M or $1.10, which is around 80% higher than its $0.60 close yesterday. Cash burn is a significant issue for ACLS. At the current rate of cash burn, we estimate the company has around six months before its liquidation value meets its current price, and around a year before it’s worthless.

The value proposition updated

During the three months ended June 30, 2009, ACLS continued to burn cash in its operations, which it attributes to the depressed semiconductor equipment market and the resultant decline in revenues. Cash and cash equivalents at June 30, 2009 were $56.8M, compared to $71.2M at March 31, 2009. The company attributes the $21.4M decrease in cash and cash equivalents to the cash used in operations and payments of fees and other costs associated with the sale of the investment in SEN. The company anticipates net cash outflows from operations in the remainder of 2009. Set out below is our adjusted balance sheet for ACLS (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

ACLS Summary 2009 6 30

We’ve been quite kind to ACLS by assuming only $50M of cash burn over the next twelve months. On its current form, $80M would have been closer to the mark. We’re assuming management takes some action to staunch the flow, but an assumptions like that might make us look like fools.

Conclusion

ACLS has made substantial operating losses over the last two years, and it is likely to be continue to do so. While its liquidation value of around $113.6M or $1.10 per share is more than 80% higher than its close yesterday of $0.60, it is likely to deteriorate while it continues its operating losses. ACLS continues to be our problem child, and we don’t think there is any good news on the horizon near-term, but we find it difficult to exit the position while it’s trading at a such a large discount to its (albeit deteriorating) liquidation value. Accordingly, we’re going to hold on for the moment, and see how the position plays out. If we get an opportunity to exit at close to value, however, we’ll take it. If the position hasn’t improved by the next Q, we’re likely sellers.

[Full Disclosure:  We have a holding in ACLS. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Updated.

Megan McArdle has written an article for The Atlantic, What Would Warren Do?, on Warren Buffett and the development of value investing, arguing that better information, more widely available, will erode the “modest advantage” value investors have over “a broader market strategy” and Warren Buffett’s demise will be the end of value investment. We respectfully disagree.

The article traces the evolution of value investing from Benjamin Graham’s “arithmetic” approach to Buffett’s “subjective” approach. McCardle writes that the rules of value investing have changed as Buffett – standard bearer for all value investors – has “refined and redefined” them for “a new era”:

When Benjamin Graham and David L. Dodd wrote the value-investing urtext, Security Analysis, in 1934, the rules were more hard-and-fast. Graham and Dodd looked for companies whose price was less than their intrinsic value, and offered various formulas for divining this value.

Buying stock in firms where the intrinsic value of the assets is higher than the market capitalization worked well in the depths of the Great Depression, when investors were wary of holding equity. Between 1929 and 1932, the Dow lost just about 90 percent of its value, bottoming out at 41.22. What economists call the “equity premium”—the extra return that investors demand to compensate for the risk of holding stocks—has never since been so high. That’s why Graham and Dodd could find companies whose liquidation value offered a substantial “margin of safety” for people who bought their equity.

Moreover, book value and other balance-sheet-based metrics have become less useful, as the market, and the economy, have changed. Persistent inflation means that the historical cost of the assets on the balance sheet in many cases bears only passing resemblance to their actual worth. Meanwhile, firms get more and more of their value from intangible assets, like intellectual property or strong brands, that don’t show up in the financial statements. Geico, one of Buffett’s crown jewels, gets much of its value not from physical equipment or even investment savvy, but from a sterling brand name built on relentless advertising.

McCardle says that the rules have changed so much that Graham’s approach no longer offers any competitive advantage:

Much of what Graham and Dodd did so well was simply hard coolie labor. In an era before spreadsheets or financial databases, they looked at company reports and painstakingly did the arithmetic to see where a company stood. That effort offers no competitive advantage in today’s information-saturated market. So while value investors still hew to the core notion of determining a company’s intrinsic value, waiting for the market to misprice the stock, and then buying on the cheap, nowadays that determination has much more of a subjective skill element.

As proof of this assertion, McCardle offers this:

Well, for starters, the market still hasn’t fallen to Graham-and-Dodd levels; most of the managers I talked to groused that they were finding few real bargains. The market was irrational enough to drag down their investment results, but too rational to offer stocks at deep discounts from intrinsic value. Meanwhile, many of their potential investors had just lost half their money.

Value investors love to deride academics and the efficient-market hypothesis, but they can’t deny that stock-screening tools and other analytics have taken away many of the best bargains. At least some managers have lost the will to wait patiently for superdeals and have taken on more risk to get more return. As we walked to dinner through the soft Omaha twilight, a fund manager I had encountered at a “meet and greet” suddenly said, “The only way to make money these days is leverage.”

And my dinner companion seemed to be saying that value managers couldn’t compete with other funds without taking at least some of those bets.

McCardle concludes with the following:

Right now, the academic literature suggests that value investing has a modest advantage over a broader market strategy. Better information, more widely available, may continue to erode that edge. But the principles of prudence, patience, and thrift will always, in the end, offer a better chance at outsize returns. The question is whether, once Saint Warren passes, his followers will find the courage to stick to them.

In response, we’d like to make the following observations:

Better information, more widely available, will not erode value’s edge

There are as many different styles of value investment as there are value investors, the uniting element being an adherence to the concept of “intrinsic value,” which is simply defined as a measure of value distinct from price. Many investors describing themselves as value investors have subtly different measures of intrinsic value, from liquidation value, to asset value, to earning power, to private market value and, if the fund manager McCardle met at the twlight “meet and greet” is an indication, some of the investors wearing the “value” badge do nothing of the sort. While investors of the same stripe often coalesce around the same opportunity, there are so many different perspectives that one type (say, the liquidation value investor) could easily sell to another (say, the earning power investor), and both could be right in their assessment of the intrinsic value of the stock, and have made money in the process. This means that diffusion of information won’t cause the value opportunities to disappear, because the interpretation of that information is the key step. As Shai points out in the comments with his Klarman quote, value investment is as much about attititude as it is about intellect or access to information. Being smart, having five screens and a Bloomberg terminal won’t get you close to Walter Schloss’ record, which he achieved with a borrowed copy of Value Line working 9.30am to 4.30pm.

Buffett has not rejected Graham, and has not redefined value

Graham’s contribution was to establish the value investment framework – the concept of intrinsic value – and to describe how one could operate successfully as an investor, most notably through the concept of margin of safety. Graham discussed a number of ideas about the manner in which intrinsic value could be assessed, and was so expansive in his teaching that he left very little ground uncovered for future value investors. It is a tribute to Buffett’s genius that he was able to find new ground within Graham’s framework, which he did by blending Phil Fisher’s philosophy with Graham’s. Buffett’s divergence from Graham’s methods was not, however, a rejection of Graham’s philosophy. Buffett has said on occassions too numerous to quote that he still works within Graham’s framework and has said that his change was a function of the increasingly large sums of capital he had to invest, and not a problem with Graham’s approach. In a June 23, 1999 Business Week article, Buffett said:

If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.

When asked in 2005 what his approach would be if he had to invest less than $10M, Buffett still indicated that he preferred Graham style securities. That’s not a rejection of Graham’s investment philosophy, or his approach.

Don’t bother looking for Graham-style opportunities, they’ve disappeared

Leave them all for us. If there was ever an investment style that should suffer from too many practioners, Graham’s “net current asset value” proxy for liquidation value investing is it. NCAV investing is about as simple as investing gets, and a free screen is all that an investor requires to find NCAV opportunities. Yet our research demonstrates that even this strategy continues to outperform the market. We probably can’t run a multi-billion dollar portfolio on the basis of a simple NCAV screen, but we’ll cross that bridge when we get to it. For the average investor, investing in Graham-style NCAV opportunities is all we’ll ever need. You say those opportunities have disappeared? Have a look at the screens on our blogroll. There are plenty there. When those opportunities do disappear – and they will eventually – it won’t be because of all those supercomputers chasing them, it’ll be a function of valuation. Prices go up, and prices come down. When they’re up, it’s hard to find investable opportunities, and when they come down, it’s easier to do so. It has always been thus, and it will always be so. When there aren’t many opportunities around, that’s a signal from the market. It’s telling you to wait. As a friend of Greenbackd says, “Patience can be a bitter plant, but it has sweet fruit.”

There are other value practitioners who will carry the torch forward

Klarman, Tweedy Browne, Greenblatt, Tilson, Dreman, Gabelli, Miller, Price, Whitman, Pabrai, Biglari (please insert any names I’ve forgotten into the comments) and a host of others toiling away in obscurity will carry the torch forward. Value investment is in good hands.

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Avigen Inc (NASDAQ:AVGN) has filed its 10Q for the period ended June 30, 2009.

One interesting aspect of the 10Q is the cost the company attributes to responding to the proxy fight and hostile tender offer:

Operating Activities. Net cash used in operating activities was $8.2 million during the six months ended June 30, 2009. Net cash used in operating activities during this period was primarily used to fund costs associated with our response to a proxy fight and hostile tender offer, and winding down clinical research and development activities, including non-clinical studies and clinical trials performed by third parties.

$8.2M? That’s $0.27 per share! Granted, some of it went to other activities, but presumably costs associated with “response to a proxy fight and hostile tender offer” was the larger portion of the $8.2M and that’s why it was listed first. It’s galling what directors are allowed to spend fighting off shareholders.

We started following AVGN in December last year (see archived posts here) because it was a net cash stock and specialist biotechnology investor Biotechnology Value Fund (BVF) was pushing it to liquidate and return its cash to shareholders. Despite BVF’s failure to remove the board, we continued to maintain our position in AVGN because BVF won a number of important concessions from the board that made AVGN a much more attractive stock than it was when we started following it. AVGN is now back in negotiations with MediciNova, Inc. regarding a proposed acquisition by MediciNova. The consideration for the deal is AVGN’s “net cash liquidation value plus $3 million” and “a contingent payment right for a specific product program milestone payment associated with Avigen’s Assignment Agreement with Genzyme Corporation, potentially subject to certain adjustments.” The stock price reflects this: AVGN closed yesterday at $1.34, up 106.2% from our $0.65 purchase price. We last estimated the net cash liquidation value at around $34M or $1.14 per share. We’ve now updated our estimate to $35M or $1.17 per share. Including the $3M from MediciNova would increase that value to around $38M or $1.27per share. We believe that there is a reasonable chance that AVGN will yield more than its current $1.34 share price when the “contingent payment right” capturing the near term payments from Genzyme is taken into account. AVGN shareholders also have an option-like exposure to any value in AVGN’s AV411 assets and program, although we cannot estimate the value of this with any certainty.

The value proposition updated

Set out below is our adjusted balance sheet for AVGN (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

AVGN Summary 2009 6 30

Conclusion

While BVF’s slate was unsuccessful at the special meeting, AVGN’s board has developed its own plan of liquidation, which should put a floor on AVGN’s stock at around its net cash value of $34M or $1.14 per share less wind down costs. There exists a good chance that AVGN will yield considerably more than its net cash value. The net cash estimate does not take into account AVGN’s AV411 assets and program or near term payments from Genzyme. With the downside protected, and a good chance at some upside from here, we think AVGN still represents good value, and we’re going to maintain our position accordingly.

[Full Disclosure: We have a holding in AVGN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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