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Posts Tagged ‘Activist investment’

There are good reasons for tracking activists. For one, research supports the view that stocks the subject of activist campaigns can generate significant above market returns, on the filing and, importantly, in the subsequent year. Recent industry research by Ken Squire, manager of the 13D Activist mutual fund (DDDAX), finds an average outperformance of 16% over the subsequent 15 months for companies larger than $1 billion in market cap:

Ken Squire is founder and principal of 13D Monitor, a research service that tracks activist investing and has data on Icahn-led activist situations since 1994, when the investor targeted Samsonite Corp. The average return of the 85 positions since then was 18.7% (measured until he closed the position, if at all), compared to 12.7% for the Standard & Poor’s 500 over comparable time frames.

Yet this impressive-seeming average outperformance should be viewed in the context of a general tendency of stocks to outperform once they have attracted the intense interest of known activist investors. In other words, this doesn’t apply to Icahn alone.

Squire calculates that, following a 13D filing, the shares of companies larger than $1 billion in market value have historically outperformed the S&P 500 by an average of 16 percentage points over the subsequent 15 months. A separate study of nearly 300 activist actions by hedge funds between April 2006 and September 2012 found a similarly strong record of success. Squire runs the relatively new (and so-far small) 13D Activist mutual fund (DDDAX), which chooses stocks from among ongoing activist situations and beat the S&P 500 by 5.27% in 2012, after fees.

Squire takes into account the past record of specific activist investors when considering fund holdings. Hedge fund JANA Partners, for example, has a strong success rate in its arm-twisting maneuvers on corporate executives it deems lacking. One of its prominent targets currently is Canadian fertilizer giant Agrium Inc. (AGU).

Squire’s research accords with earlier studies on this site, most notably these two:

  1. In Entrepreneurial Shareholder Activism: Hedge Funds and Other Private Investors, April Klein and Emanuel Zur examined recent “confrontational activism campaigns” by “entrepreneurial shareholder activists” and concluded that such strategies generate “significantly positive market reaction for the target firm around the initial Schedule 13D filing date” and “significantly positive returns over the subsequent year.” The authors find that the filing of a 13D notice by an activist hedge fund is a catalytic event for a firm that heralds substantial positive returns in the stock. Klien and Zur found that “hedge fund targets earn 10.2% average abnormal stock returns during the period surrounding the initial Schedule 13D. Other activist targets experience a significantly positive average abnormal return of 5.1% around the SEC filing window. These findings suggest that, on average, the market believes activism creates shareholder value. … Furthermore, our target abnormal returns do not dissipate in the 1-year period following the initial Schedule 13D. Instead, hedge fund targets earn an additional 11.4% abnormal return during the subsequent year, and other activist targets realize a 17.8% abnormal return over the year following the activists’ interventions.”
  2. In Hedge Fund Activism, Corporate Governance, and Firm Performance, authors Brav, Jiang, Thomas and Partnoy found that the “market reacts favorably to hedge fund activism, as the abnormal return upon announcement of potential activism is in the range of [7%] seven percent, with no return reversal during the subsequent year.” Further, the paper “provides important new evidence on the mechanisms and effects of informed shareholder monitoring.”

h/t @reformedbroker

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Update: See Ryan’s interview on Bloomberg.

Great article from Businessweek about Ryan Morris, the 28-year-old Canadian managing partner of Meson Capital Partners, LLC who “resembles a sandy-haired Mitt Romney,” and seems to be all out of bubblegum:

Ryan Morris spent a week steeling himself for the showdown. Then 27 years old, he was in his first campaign as an activist investor, trying to wrest control of a small company named InfuSystem (INFU), which provides and services pumps used in chemotherapy. In the meeting, Morris would confront InfuSystem’s chairman and vice chairman, two men in their 40s, and tell them that as a shareholder, he thought the company was heading in the wrong direction.

Morris is competitive—his high school rowing teammates nicknamed him “Cyborg,” and he took a semester off college to race as a semi-pro cyclist—but face-to-face confrontation wasn’t something he relished. “I like the thrill of the hunt, but not the kill,” he says. To prepare, Morris outlined questions, guessed potential responses, and tried to anticipate what tense “pregnant moments” could arrive. He built his clout by lining up support from InfuSystem’s largest shareholder as well as a veteran activist investor. Morris knew his own looks—he resembles a sandy-haired Mitt Romney—could help mask his youth, and decided he’d wear a tie, much as he hates to.

The company, with just $47 million in revenue, was spending too much money, and in the wrong places. In the previous year, InfuSystem’s board and CEO earned more than $11 million combined. This was for a company whose stock had lost 40 percent of its value over the previous three years. Morris figured that as a shareholder voice on the board, he could help cut expenses—including the high pay—and, once it was clean enough to sell, reap a return for his own small hedge fund.

On Dec. 13, 2011, he finally sat at a conference table across from the two directors. After 45 minutes of discussion, he still didn’t think his concerns were being acknowledged. So he got to the point: He wanted three board seats.

It’s a great story. Read the rest of the article on Businessweek.

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Embedded below is my Fall 2012 strategy paper, “Hunting Endangered Species: Investing in the Market for Corporate Control.

From the executive summary:

The market for corporate control acts to catalyze the stock prices of underperforming and undervalued corporations. An opportunity exists to front run participants in the market for corporate control—strategic acquirers, private equity firms, and activist hedge funds—and capture the control premium paid for acquired corporations. Eyquem Fund LP systematically targets stocks at the largest discount from their full change‐of‐control value with the highest probability of undergoing a near‐term catalytic change‐of‐control event. This document analyzes in detail the factors driving returns in the market for corporate control and the immense size of the opportunity.


Hunting Endangered Species: Investing in the Market for Corporate Control Fall 2012 Strategy Paper

This is the investment strategy I apply in the Eyquem Fund. It is obviously son-of-Greenbackd (deep value, contrarian and activist follow-on) and, although it deviates in several crucial aspects, it is influenced by the 1999 Piper Jaffray research report series, Wall Street’s Endangered Species.

For more of my research, see my white paper “Simple But Not Easy: The Case For Quantitative Value” and the accompanying presentation to the UC Davis MBA value investing class.

As always, I welcome any comments, criticisms, or questions.

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Which price ratio best identifies undervalued stocks? It’s a fraught question, dependent on various factors including the time period tested, and the market capitalization and industries under consideration, but I believe a consensus is emerging.

The academic favorite remains book value-to-market capitalization (the inverse of price-to-book value). Fama and French maintain that it makes no difference which “price-to-a-fundamental” is employed, but if forced to choose favor book-to-market. In the Fama/French Forum on Dimensional Fund Advisor’s website they give it a tepid thumbs up despite the evidence that it’s not so great:

Data from Ken French’s website shows that sorting stocks on E/P or CF/P data produces a bigger spread than BtM over the last 55 years. Wouldn’t it make sense to use these other factors in addition to BtM to distinguish value from growth stocks? EFF/KRF: A stock’s price is just the present value of its expected future dividends, with the expected dividends discounted with the expected stock return (roughly speaking). A higher expected return implies a lower price. We always emphasize that different price ratios are just different ways to scale a stock’s price with a fundamental, to extract the information in the cross-section of stock prices about expected returns. One fundamental (book value, earnings, or cashflow) is pretty much as good as another for this job, and the average return spreads produced by different ratios are similar to and, in statistical terms, indistinguishable from one another. We like BtM because the book value in the numerator is more stable over time than earnings or cashflow, which is important for keeping turnover down in a value portfolio. Nevertheless, there are problems in all accounting variables and book value is no exception, so supplementing BtM with other ratios can in principal improve the information about expected returns. We periodically test this proposition, so far without much success.

There are a variety of papers on the utility of book value that I’ve beaten to death on Greenbackd. I used to think it was the duck’s knees because that was what all the early research seemed to say (See, for example, Roger Ibbotson’s “Decile Portfolios of the New York Stock Exchange, 1967 – 1984,” Werner F.M. DeBondt and Richard H. Thaler’s “Further Evidence on Investor Overreaction and Stock Market Seasonality”). Josef Lakonishok, Andrei Shleifer, and Robert Vishny’s Contrarian Investment, Extrapolation and Risk, which was updated by The Brandes Institute as Value vs Glamour: A Global Phenomenon reopened the debate, suggesting that price-to-earnings and price-to-cash flow might add something to price-to-book.

A number of more recent papers have moved away from book-to-market, and towards the enterprise multiple ((equity value + debt + preferred stock – cash)/ (EBITDA)). As far as I am aware, Tim Loughran and Jay W. Wellman got in first with their 2009 paper “The Enterprise Multiple Factor and the Value Premium,” which was a great unpublished paper, but became in 2010 a slightly less great published paper, “New Evidence on the Relation Between the Enterprise Multiple and Average Stock Returns,” suitable only for academics and masochists (but I repeat myself). The abstract to the 2009 paper (missing from the 2010 paper) cuts right to the chase:

Following the work of Fama and French (1992, 1993), there has been wide-spread usage of book-to-market as a factor to explain stock return patterns. In this paper, we highlight serious flaws with the use of book-to-market and offer a replacement factor for it. The Enterprise Multiple, calculated as (equity value + debt value + preferred stock – cash)/ EBITDA, is better than book-to-market in cross-sectional monthly regressions over 1963-2008. In the top three size quintiles (accounting for about 94% of total market value), EM is a highly significant measure of relative value, whereas book-to-market is insignificant.

The abstract says everything you need to know: Book-to-market is widely used (by academics), but it has serious flaws. The enterprise multiple is more predictive over a long period (1963 to 2008), and it’s much more predictive in big market capitalization stocks where book-to-market is essentially useless.

What serious flaws?

The big problem with book-to-market is that so much of the return is attributable to nano-cap stocks and “the January effect”:

Loughran (1997) examines the data used by Fama and French (1992) and finds that the results are driven by a January seasonal and the returns on microcap growth stocks. For the largest size quintile, accounting for about three-quarters of total market cap, Loughran finds that BE/ME has no significant explanatory power over 1963-1995. Furthermore, for the top three size quintiles, accounting for about 94% of total market cap, size and BE/ME are insignificant once January returns are removed. Fama and French (2006) confirm Loughran’s result over the post- 1963 period. Thus, for nearly the entire market value of largest stock market (the US) over the most important time period (post-1963), the value premium does not exist.

That last sentence bears repeating: For nearly the entire market value of largest stock market (the US) over the most important time period (post-1963), the value premium does not exist, which means that book-to-market is not predictive in stocks other than the smallest 6 percent by market cap. What about book-to-market in the stocks in that smallest 6 percent? It might not work there either:

Keim (1983) shows that the January effect is primarily limited to the first trading days in January. These returns are heavily influenced by December tax-loss selling and bid-ask bounce in low-priced stocks. Since many fund managers are restricted in their ability to buy small stocks due to ownership concentration restrictions and are prohibited from buying low-prices stocks due to their speculative nature, it is unlikely that the value premium can be exploited.

More scalable

The enterprise multiple succeeds where book-to-market fails.

In the top three size quintiles, accounting for about 94% of total market value, EM is a highly significant measure of relative value, whereas BE/ME is insignificant and size is only weakly significant. EM is also highly significant after controlling for the January seasonal and removing low-priced (<$5) stocks. Robustness checks indicate that EM is also better to Tobin’s Q as a determinant of stock returns.

And maybe the best line in the  paper:

Our results are an improvement over the existing literature because, rather than being driven by obscure artifacts of the data, namely the stocks in the bottom 6% of market cap and the January effect, our results apply to virtually the entire universe of US stocks. In other words, our results may actually be relevant to both Wall Street and academics.

Why does the enterprise multiple work?

The enterprise multiple is a popular measure, and for other good reasons besides its performance. First, the enterprise multiple uses enterprise value. A stock’s enterprise value provides more information about its true cost than its market capitalization because it includes information about the stock’s balance sheet, including its debt, cash and preferred stock (and in some variations minorities and net payables-to-receivables). Such things are significant to acquirers of the business in its entirety, which, after all, is the way that value investors should think about each stock. Market capitalization can be misleading. Just because a stock is cheap on a book value basis does not mean that it’s cheap 0nce its debt load is factored into the valuation. Loughran and Wellman, quoting Damodaran (whose recent paper I covered here last week), write:

Damodaran shows in an unpublished study of 550 equity research reports that EM, along with Price/Earnings and Price/Sales, were the most common relative valuation multiples used. He states, “In the past two decades, this multiple (EM) has acquired a number of adherents among analysts for a number of reasons.” The reasons Damodaran cites for EM’s increasing popularity also point to the potential superiority of EM over book-to-market. One reason is that EM can be compared more easily across firms with differing leverage. We can see this when comparing the corresponding inputs of EM and BE/ME. The numerator of EM, Enterprise Value, can be compared to the market value of equity. EV can be viewed as a theoretical takeover price of a firm. After a takeover, the acquirer assumes the debt of the firm, but gains use of the firm’s cash and cash equivalents. Including debt is important here. To take an example, in 2005, General Motors had a market cap of $17 billion, but debt of $287 billion. Using market value of equity as a measure of size, General Motors is a mid-sized firm. Yet on the basis of Enterprise Value, GM is a huge company. Market value of equity by itself is unlikely to fully capture the effect GM’s debt has on its returns. More generally, it is reasonable to think that changing firm debt levels may affect returns in a way not fully captured by market value of equity. Bhojraj and Lee (2002) confirm this, finding that EV is superior to market value of common equity, particularly when firms are differentially levered.

The enterprise multiple’s ardor for cash and abhorrence for debt matches my own, hence why I like it so much. In practice, that tendency can be a double-edged sword. It digs up lots of little cash boxes with a legacy business attached like an appendix (think Daily Journal Corporation (NASDAQ:DJCO) or Rimage Corporation (NASDAQ:RIMG)). Such stocks tend to have limited upside. On the flip side, they also have happily virtually no downside. In this way they are vastly superior to the highly leveraged pigs favored by book-to-market, which tends to serve up heavily leveraged slivers of somewhat discounted equity, and leaves you to figure out whether it can bear the debt load. Get it wrong and you’ll be learning the intricacies of the bankruptcy process with nothing to show for it at the end. When it comes time to pull the trigger, I generally find it easier to do it with a cheap enterprise multiple than a cheap price-to-book value ratio.

The earnings variable: EBITDA

There’s a second good reason to like the enterprise multiple: the earnings variable. EBITDA contains more information than straight earnings, and so should give a more full view of where the accounting profits flow:

The denominator of EM is operating income before depreciation while net income (less dividends) flows into BE. The use of EBITDA provides several advantages that BE lacks. Damodaran notes that differences in depreciation methods across companies will affect net income and hence BE, but not EBITDA. Also, the McKinsey valuation text notes that operating income is not affected by nonoperating gains or losses. As a result, operating income before depreciation can be viewed as a more accurate and less manipulable measure of profitability, allowing it to be used to compare firms within as well as across industries. Critics of EBITDA point out that it is not a substitute for cash flow; however, EV in the numerator does account for cash.

The enterprise multiple includes debt as well as equity, contains a clearer measure of operating profit and captures changes in cash from period to period. The enterprise multiple is a more complete measure of relative value than book-to-market. It also performs better:

Performance of the enterprise multiple versus book-to-market

From CXOAdvisory:

  • EM generates an annual value premium of 5.8% per year over the entire sample period (compared to 4.8% for B/M during 1926-2004).
  • EM captures more premium than B/M for all five quintiles of firm size and is much less dependent on small stocks for its overall premium (see chart below).
  • In the top three quintiles of firm size (accounting for about 94% of total market capitalization), EM is a highly significant measure of relative value, while B/M is not.
  • EM remains highly significant after controlling for the January effect and after removing low-priced (<$5) stocks.
  • EM outperforms Tobin’s q as a predictor of stock returns.
  • Evidence from the UK and Japan confirms that EM is a highly significant measure of relative value.

The “value premium” is the difference in returns to a portfolio of glamour stocks (i.e., the most expensive decile) when compared to a portfolio of value stocks (i.e., the cheapest decile) ranked on a given price ratio (in this case, the enterprise multiple and book-to-market). The bigger the value premium, the better a given price ratio sorts stocks into winners and losers. It’s a more robust test than simply measuring the performance of the cheapest stocks. Not only do we want to limit our sins of commission (i.e., buying losers), we want to limit our sins of omission (i.e., not buying winners). 

Here are the value premia by market capitalization (from CXOAdvisory again): Ring the bell. The enterprise multiple kicks book-to-market’s ass up and down in every weight class, but most convincingly in the biggest stocks.

Strategies using the enterprise multiple

The enterprise multiple forms the basis for several strategies. It is the price ratio limb of Joel Greenblatt’s Magic Formula (the other limb is of course return on invested capital, which I like about as much as Hunter S. Thompson liked Richard Nixon, about whom he said in his obituary:

[The] record will show that I kicked him repeatedly long before he went down. I beat him like a mad dog with mange every time I got a chance, and I am proud of it. He was scum.

But I digress.) It also forms the basis for the Darwin’s Darlings strategy that I love (see Hunting Endangered Species). The Darwin’s Darlings strategy sought to front-run the LBO firms in the early 2000s, hence the enterprise multiple was the logical tool, and highly effective.

Conclusion

This post was motivated by the series last week on Aswath Damodaran’s paper ”Value Investing: Investing for Grown Ups?” in which he asks, “If value investing works, why do value investors underperform?Loughran and Wellman also asked why, if Fama and French (2006) find a value premium (measured by book-to-market) of 4.8% per year over 1926-2004, mutual fund managers couldn’t capture it:

Fund managers perennially underperform growth indices like the Standard and Poor’s 500 Index and value fund managers do not outperform growth fund managers. Either the value premium does not actually exist, or it does not exist in a way that can be exploited by fund managers and other investors.

Loughran and Wellman find that for nearly the entire market value of largest stock market (the US) over the most important time period (post-1963), the value premium does not exist, which means that book-to-market is not predictive in stocks other than the smallest 6 percent by market cap (and even there the returns are suspect). The enterprise multiple succeeds where book-to-market fails. In the top three size quintiles, accounting for about 94% of total market value, the enterprise multiple is a highly predictive measure, while book-to-market is insignificant. The enterprise multiple also works after controlling for the January seasonal effect and after removing low priced (<$5) stocks. The enterprise multiple is king. Long live the enterprise multiple.

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Kinnaras Capital Management demonstrates characteristic tenacity in a new letter to Media General Inc (NYSE:MEG) sent after Kinnaras’s exclusion from the most recent earnings call:

I intended to voice those concerns on the Q1 2012 conference call but despite following directions to join the queue, it appears that I was not allowed to participate in this call. This is a poor response to an engaged shareholder. I have likely purchased more shares of MEG than you ever have, yet as an owner of the Company I was not allowed to ask pertinent questions regarding MEG’s operational and financing strategies simply because I have accurately pointed out the various failures you have helmed while at Media General.

In its two earlier lettera Kinnaras expressed frustration with the performance of MEG, and urged the Board to “take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The initial letter included Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the new letter:

Kinnaras also has on its website its recommendations to MEG shareholders ahead of the proxy vote.

No position.

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Kinnaras Capital Management has sent a follow up letter to Media General Inc (NYSE:MEG) requesting the board “selloff MEG in its entirety and divorce this company from the inept management team currently at the helm.”

In its earlier letter Kinnaras expressed frustration with the performance of MEG, and urged the Board to “take advantage of the robust M&A market for both newspaper and broadcast television and to sell all operating units of MEG in order to retire existing corporate and pension debt and achieve a share price shareholders have rarely seen in recent years.”

MEG is a provider of local news in small and mid-size communities throughout the Southeastern United States. It owns three metropolitan and 20 community newspapers and 18 network-affiliated broadcast television stations Virginia/Tennessee, Florida, Mid-South, North Carolina, and Ohio/Rhode Island.

The initial letter included Kinnaras’s sum-of-the-parts valuation, which Kinnaras Managing Member Amit Chokshi sees at $9.75 per share against a prevailing price of around $4.60.

Here’s the follow up letter:

Kinnaras also has on its website its recommendations to MEG shareholders ahead of the proxy vote.

No position.

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Amit Chokshi of Kinnaras Capital, an independent registered investment advisor focused on deep-value, small capitalization and micro capitalization equity investing, has contributed a guest post on Imation Corp (NYSE:IMN).

About Kinnaras:

Kinnaras aims to deliver above average long-term results through application of a deep value investment strategy.  As a result, the Firm focuses on the “throwaways” of the equity market, or stocks that are generally viewed as broken from a fundamental standpoint.  The Firm utilizes a fundamental, bottom-up, research-intensive approach to security selection, focusing mainly on prospects trading below book and/or tangible book value or cheap price to free cash flow. Kinnaras is a strong advocate of mean reversion and has found that pessimistic valuations, and thus attractive investment opportunities, often manifest when the broader investment community disregards mean reversion and impounds overly pessimistic expectations into security prices.  When valuation incorporates these pessimistic assumptions, the risk/reward scenario favors the investor.

Imation Worth More Sold Than Alone

As a deep value investor, one is always confronted with companies that have potentially great assets but can be overshadowed by poor management.  As a deep value investor, often times a great stock is not necessarily a great company but the overall value available from an investment standpoint is too attractive to pass up.  Based on its current valuation, IMN appears to fall into this category.

IMN is a global developer and marketer of branded storage/recording products focused on optical media, magnetic tape media, flash and hard drive products and consumer electronic products.  The company has significant global scale and its brand portfolio includes the Imation, Memorex, and XtremeMac brands.  The company is also the exclusive licensee of the TDK Life on Record brand.

IMN has high brand recognition and is a leader in its key categories of optical and magnetic tape media.  While the company faces long term secular challenges with regards to how data is stored, the current valuation appears to be highly muted due to a number of strategic and capital allocation blunders over the company’s past 5+ years.  Management would be doing shareholders a greater service by simply putting the company up for sale given the time allotted for a number of strategic moves to play out unsuccessfully in recent years.  Moreover, IMN has been on an acquisition spree in 2011 and existing shareholders may see further value destruction given the track record of management.  The following highlights some key grievances shareholders should have with IMN’s current strategy

Horrific Capital Allocation by Management: IMN’s cash balance serves as somewhat of a fundamental backstop against permanent capital loss.  The problem, however, is that the company’s net cash balance has been used to fund a number of bad decisions, particularly M&A.  Management has acquired a number of businesses in recent years, none of which have benefited shareholders.  These acquisitions of businesses and intellectual property (“IP”) have led to clear value destruction as evidenced by IMN’s sales and operating income performance since those acquisitions along with on going write-offs of goodwill tied to a number of those purchases and constant restructuring charges eating into book equity.

One example of how poor management’s acquisition strategy was its purchase of BeCompliant Corporation (Encryptx) on February 28, 2011 which resulted in $1.6MM in goodwill.  In less than five weeks, IMN had determined the goodwill tied to this acquisition to be fully impaired!  While $1.6MM is a tiny amount, Table I highlights the total value of goodwill written off by IMN in recent years along with the ongoing restructuring charges in the context of the company’s historical acquisition capex.

TABLE I: IMN ACQUISITION CAPEX & IMPAIRMENT, RESTRUCTURING CHARGES ($MM) [Click to expand]

Since 2006, IMN management has deployed $442MM in cash to acquire a variety of businesses.  Since that time, investors have had to experience $152MM in goodwill write-offs and another $169MM in restructuring charges as IMN fumbles in regards to integrating newly acquired and existing business segments for a grand total of $320MM in charges since 2006.  IMN management is clearly a poor steward of capital.   What’s worse is that shareholders experienced value destruction at the expense of exercises which would have returned cash to shareholders.

For example, after 2007 IMN ceased paying a dividend.  The annual dividend returned over $20MM to investors annually.  Rather than provide investors with a certain return in the form of a dividend, IMN management has used that capital to obviously overpay for businesses such as Encryptx.  Another demonstration of poor capital allocation by management is its stock buyback history.  From 2005-2008, IMN spent nearly $190MM to buyback shares when its stock was valued at levels ranging from 0.4-1.1x P/S and 0.8-1.6x P/B or $14-$48 per share.  The average acquired share price of IMN’s treasury stock was $23.39.

Since 2008, IMN’s share price has ranged from its recent multi year low of $5.40 to about $14 (for a brief period in early 2009).  More importantly, IMN’s valuation has ranged from 0.15-0.25 P/S and 0.28-0.36 P/B.  So while IMN has had more than enough cash to purchase shares since that time, from 2009 on, IMN management decided to repurchase just under $10MM of stock.  This exemplifies management’s history of overpaying for assets – whether it’s businesses, IP, or the company’s own shares.

Management has no meaningful investment in IMN:  There has been considerable insider purchases since July 2011 across a number of companies.  IMN has had no major inside purchases despite the current low share price.  IMN CEO made an immaterial purchase in the open market very recently but overall, while  IMN stock has floundered, management has experienced none of the setbacks of shareholders for its inept strategy.  As mentioned above, management had the company execute on a number of buybacks from 2005-2008.  However, the overall effect of those buybacks were considerably offset by significant issuance of stock compensation.  As a result, IMN’s overall share count continued to grow despite these share buybacks.  In summary, management has demonstrated little appetite for the company’s shares, irrespective of valuation, while expecting shareholders to sit idly by while it awards itself dilutive stock compensation off the backs of investors.

There is no question that IMN has its share of challenges but is there value to be unlocked?  At current valuations, it appears that significant upside is potentially available if IMN investors can take an activist stance.  Management has had its chances for many years and it is clearly time to explore other options.  Despite the secular challenges IMN faces, the company is still worth more than current prices.  The following highlights the good aspects of IMN.

Valuation:  IMN is cheap based on a number of valuation metrics.  First, at $5.81 per share as of Monday’s (11/28/11) market close, IMN has a negative enterprise value.  IMN has $6.21 in net cash per share and the current share price means that the market is ascribing a negative value to IMN’s core operating business.  Given the number of patents and intellectual property along with a business that can generally crank out solid cash flow, IMN’s main businesses should not have a negative value despite the longer term secular challenges it faces.  On a capital return basis, IMN management should have the company repurchase shares at this level but that may be expecting far too much from management given its track record.

IMN is also trading at valuation levels below those reached even in 2008-09.  As Table II shows, IMN has not traded at levels this low at least since 2003.  Long-term challenges in its core business segments along with value destroying management are two reasons for these metrics grinding lower but at a certain point, valuation can become rather compelling.  I think current prices and valuation may reflect “highly compelling” from an investment standpoint.

TABLE II: IMN HISTORICAL VALUATION [Click to expand]

IMN’s current valuation could be ascribed to a company with major near-term problems, typical of those that burn considerable cash and have poor balance sheets characterized by high levels of debt and/or near-term refinancings.  IMN does not fit into this description.  As bad as IMN is performing, it is still on track for a positive free cash flow in 2011.  IMN has modest capital expenditure needs and IMN’s gross margins have been increasing in 2011, approaching gross margins realized in 2007.  Table III presents my estimate for FY 2011 excluding IMN’s non-cash restructuring charges and write-offs.  To be clear, a potential acquirer would also use pro forma statements in determining IMN’s value.

TABLE III: IMN 2011 SUMMARY OPERATING DATA

Using a highly conservative multiple of just 3.0x 2011 pro forma EBITDA of $49MM leads to a share price of $10.  What is clear from Table III is that if management could avoid squandering capital on acquisitions, IMN can still generate attractive free cash flow.  In addition, with a net cash balance of $233MM or $6.21/share, IMN should not generally be paying any net interest expense if that capital was better managed/allocated for cash management purposes.  A history of poor capital allocation and strategic blunders has led to IMN carrying a heavily discounted valuation.  At about $5.80, a case could be made that IMN is trading at or below liquidation value as presented in Table IV.

TABLE IV: IMN LIQUIDATION VALUE PER SHARE

Table IV shows that the major wildcard is really the value of IMN’s intangible assets.  While IMN is facing secular challenges, the IP it carries could very well have value to a potential acquirer, especially at an attractive valuation.  IMN maintains a long-term exclusive license with TDK which expires in 2032.  TDK, which owns nearly 20% of IMN, could bless a sale that allows those licenses to pass on to an acquiring company.  Aside from the TDK license, IMN holds over 275 patents.  IMN has recently entered into security focused technology for the purposes of flash and hard drive storage.  This technology uses various advanced password/encryption technology along with biometric authentication and could very well be worth much more to a larger technology company that could more broadly exploit this IP across its technology.  This is just one example of various IP IMN possesses.  In addition, IMN has leading market share and brand recognition/value in a number of areas such as optical media along with magnetic tape media.  A competitor like Sony Corp (“SNE”) or a client like IBM or Oracle (“ORCL”), both of which use IMN’s magnetic tape media in their own products for disaster storage/recovery and archiving, could find IMN’s IP of value.

TABLE V: IMN LIQUIDATION VALUE BASED ON INTANGIBLE ASSET DISCOUNT

If IMN’s IP and thus its intangible assets are absolutely worthless, IMN would be worth under $2 in a fire sale liquidation.  However, at even a 50% haircut of IP, IMN gets to where its stock is currently trading.  The less severe the discount, the more IMN is worth in a liquidation.  That’s hardly a groundbreaking statement but what if IMN’s IP is actually worth more than its carrying value?

TABLE VI: IMN LIQUIDATION VALUE BASED ON INTANGIBLE ASSET PREMIUM

What is clear is that IP has considerable value and in many cases eclipses the actual on-going business value of a number of companies.  The recent lawsuit between Micron Technology (“MU”) and Rambus Inc (“RMBS”) was for IP claims that could have yielded nearly $4B in royalties (before potentially tripling under California law) for RMBS. RMBS commanded a market valuation of roughly$2B before MU won the lawsuit.

Motorola Mobility Holdings (“MMI”) faced very challenging headwinds in the mobile device space against tough competitors such as Apple (“AAPL”), Samsung, HTC, and others.  This was reflected in the stock losing significant value once being spun off from Motorola (about 25% from its initial spin-off price).  Nonetheless, Google (“GOOG”) saw value in MMI’s IP, enough to offer a share price that was essentially 100% above its at-the-time lows.

Eastman Kodak (“EK”) has a number of operating challenges and a far less attractive balance sheet relative to RMBS, MMI, and IMN.  The company is wracking up losses and has a $1.2B pension shortfall.  Nonetheless, IP specialists MDB Capital believe that EK’s IP could be worth $3B in a sale.  EK currently has a market capitalization of just $295MM.

What is clear is that there is a wide range of valuation outcomes dependent on the value of the IP to a potential buyer.  IMN could be an easy and accretive acquisition to a number of large technology firms.  Firms like SNE, Maxell, and Verbatim could find IMN attractive for its leading position in optical media.  SNE could also find IMN’s magnetic storage division of value, as could IBM and ORCL.  IMN’s emerging storage division encompasses USB, hard disk drives, and flash drives (admittedly not really “emerging”) but has a particular focus on security focused applications in this storage format.  The IP related to biometric authentication and advanced encryption could be of value to a number of storage/storage tech companies such as Western Digital Corp (“WDC”), Seagate Technology (“STX”), SanDisk Corp. (“SNDK”), Micron Technology (“MU”). Even larger enterprise storage and software companies such EMC Corp (“EMC”), IBM, and ORCL could find this segment of value.  The small consumer electronics segment could be of interest to a company like Audiovox (“VOXX”).  However, in any case, all of IMN could be acquired at a very attractive price to nearly any large technology firm/buyer.

At a takeout price of just $10 per share, for example, an acquirer would be buying IMN’s core business for just $142MM with $6.21 of the $10 offer represented by IMN’s net cash.  This small deal size could very well lead to a quick payback period for a number of larger firms that could exploit IMN’s IP across multiple channels.  IMN could also be sold off in piecemeal fashion but given its small size and number of large technology companies that can utilize IMN’s IP, folding the entire company at an attractive price could be the easiest road.

Management and the board have had more than enough time in recent years to transform IMN or move it forward.  The operating results clearly show that this strategy is costing shareholders greatly and management appears to have little competence with regards to understanding how best to deploy capital.  Nearly $200MM was spent to repurchase far more expensive IMN shares prior to 2008 while a pittance of IMN capital has been deployed to buyback shares when the stock is trading for less than its net cash value.  In addition, upon ceasing its payment of annual dividend, IMN management has utilized that cash to pursue questionable acquisitions.  These acquisitions have led to destruction of shareholder equity given the subsequent writedowns and constant restructuring charges experienced by IMN.  The bottom line is IMN investors should pursue an activist stance and encourage management and the board to seek a sale for the sake of preserving what value is left in the company.

DISCLOSURE: AUTHOR MANAGES A HEDGE FUND AND MANAGED ACCOUNTS LONG IMN AND MU.

Greenbackd Disclosure: No Position.

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In The value of Seth Klarman (free registration required), Absolute Return has a rare interview with the president and portfolio manager of the 28-year-old Baupost Group. In the interview, Klarman discusses several of Baupost’s positions over the last twelve months, including the fund’s stake in Facet Biotech, which I fumbled last year:

Around the same time the CIT deal was playing out, Klarman took a sizable stake in Facet Biotech—a small biotech company spun off in December 2008 from PDL BioPharma—for an average cost of $9 even though it had $17 per share in net cash at the time of the spinoff. “We liked the discount and pipeline of products,” Klarman recalls. “We knew that when small caps are spun off, they are frequently ignored and become cheap.”

Biogen Idec tried to acquire Facet in a hostile deal for $14.50 per share, raising the offer later to $17.50. When Facet allowed its largest shareholder, Biotech Value Fund, to buy up to 20% of the company, Baupost asked for identical terms, essentially becoming a poison pill. Baupost then told Facet it did not intend to tender its shares in the $17.50 per share offer. Eventually Biogen backed off, and Facet accepted a $27 per share offer from Abbott Laboratories.

Here Klarman discusses his strategy more broadly:

Value investors are typically thought of as stock investors, but Klarman says most of the time he prefers to buy bonds. Bonds are a senior security, offering more safety, and they have a catalyst built into them. Unlike equity, debt pays current principal and interest. If the issuer doesn’t make that timely payment, an investor can take action. “Catalysts can reduce your dependence on the level of the market or action of the market,” he explains. For example, defaults are specific incidents affecting the company regardless of what is going on in the overall market.

Over the past two years, Klarman’s preference for debt has been even more pronounced. After peaking at just $2 billion in June 2008, Baupost’s total equity assets shrank to around $1.2 billion from the fourth quarter of 2008 to the first half of 2009, before turning up slightly at year-end 2009 to nearly $1.6 billion. That puts equities at just a little more than 7% of total assets under management.

And his view on the market

The value pro is still looking at troubled companies, mortgage securities and select equities. But he is not buying much at the moment. Klarman says there are some opportunities in commercial real estate on the private side, but not as much as would be expected, given the depressed levels of the market. “That’s why we want to be patient,” he stresses.

Baupost is 30% in cash now, its long-time average. Klarman stresses that the cash position is residual—the result of a search for opportunity and not the result of a macro view. He says he can find great opportunities to buy at the same time he has a bearish view on the world. “We’re good at finding bargains, good at doing analysis,” he emphasizes. “We’re not good at calling short-term movements in the markets.”

And when the markets started to crumble in mid-May, he mostly stood pat, asserting that the 5% to 8% drop in prices did not unleash a torrent of bargains, mostly because of the market’s surge from its March 2009 bottom. “The market has gone up so much that, based on valuation, it is overvalued again to a meaningful degree where the expected returns logically from here can be as low as the low single digits or zero for the next several years,” he says.

Click here to see the remainder of the interview (free registration required).

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Mario Cibelli’s recent 13D amendment for Dover Motorsports Inc (NYSE:DVD) is interesting reading. Cibelli controls around 17.5% of DVD through Marathon Partners and Cibelli Capital Management. His most recent 13D amendment filed Wednesday annexes a letter setting out a (huge) case study of DVD “partly as a contribution to public education but also to obtain a clearly objective review of the Dover Motorsports situation for our own investment purposes:”

Via Fed-Ex

April 26, 2010

Trustees of RMT Trust
Michele M. Rollins
R. Randall Rollins
Henry B. Tippie
Board of Directors, Dover Motorsports, Inc.
Henry B. Tippie, Chairman
Denis McGlynn, Chief Executive Officer
Patrick J. Bagley
Kenneth K. Chalmers
Jeffrey W. Rollins
John W. Rollins, Jr.
R. Randall Rollins
Eugene W. Weaver
Dover Motorsports, Inc.
1311 N. DuPont Highway
Dover, Delaware 19903

RE: Dover Motorsports, Inc. Case Study

Dear Trustees of RMT Trust and Board Members:

Please find enclosed a study that we sponsored, partly as a contribution to public education but also to obtain a clearly objective review of the Dover Motorsports situation for our own investment purposes.

We believe this objective and thorough review confirms our position that Mr. Tippie has not been performing his duties satisfactorily, and cannot be relied upon to do so in the future. We recognize that Mr. Tippie’s past accomplishments are significant and worthy of admiration, but whatever tribute is due cannot be imposed on the company’s long-suffering shareholders. Under these circumstances, it is the fiduciary responsibility of the company’s directors as well as of the trustees of its controlling shareholder to act in the interest of those who rely upon them to assure the competent management of Dover Motorsports.

If you are reluctant to take the necessary actions yourselves, you should at least allow me to do so. As you know from our reports, I have made sound preparations to assume this responsibility.

Sincerely,

Mario D. Cibelli
Managing Member

Enclosure

Cibelli’s DVD case study:

Isaac C. Flanagan

April 26, 2010

Dancing on the Deck of the Titanic:
Henry B. Tippie and Dover Motorsports, Inc.

As the first decade of the 21st century rapidly drew to a close, the motorsports industry in the United States faced shifting internal dynamics, and was buffeted by the macroeconomic environment. The third-largest public player in a sector whose decades-long cycle of consolidation was largely complete, Dover Motorsports, Inc. (NYSE: DVD) (“Dover Motorsports,” “Dover” or the “Company”) was not immune.

By the time Henry B. Tippie was elected Chairman of Dover’s Board of Directors in 2000 following the death of Company founder and Chairman John W. Rollins, he had distinguished himself through nearly fifty years of service to the Rollins family and their group of companies. In his career, Mr. Tippie had developed a reputation for consistently organizing and growing companies in a diverse group of industries, frequently taking them public. Mr. Tippie was known not only as a successful manager and a nimble rescuer of companies, but also as a leader with unimpeachable integrity. The University of Iowa described Henry Tippie in the following manner on the biographical web page entitled Who is Henry Tippie?:

“Integrity. Innovation. Impact.

Those words not only apply to the Tippie College and its offerings, they also apply to its benefactor, Henry B. Tippie. A native of Belle Plaine, Iowa, Henry Tippie is a man of integrity, who has built his personal and professional life on the principles of hard work and doing the right thing. He is a living and breathing illustration of the word ‘integrity.'”1

1 http://tippie.uiowa.edu/about/henry.cfm

It is in this context that the circumstances surrounding Dover Motorsports could have been confusing to those familiar with the situation starting in 2007. The management decisions made over a long period of time at Dover seemed contradictory to the legacy of both Mr. Tippie and the Rollins group of companies and left Dover at a major crossroads in 2009.

Company Description

Dover Motorsports, Inc., headquartered in Dover, Delaware, marketed and promoted motorsports entertainment in the United States via the following four raceways:

1. Dover International Speedway in Dover, Delaware

2. Gateway International Raceway near St. Louis, Missouri

3. Memphis Motorsports Park in Memphis, Tennessee

4. Nashville Superspeedway in Lebanon, Tennessee

The Sprint Cup Series was NASCAR’s premier racing series, with 36 races scheduled in 2009 and 36 more scheduled in 2010. Dover International Speedway hosted two Sprint Cup Series race weekends each year, and was the only one of the Company’s four tracks to host a Sprint Cup Series event. All four facilities hosted NASCAR Nationwide Series and Camping World Truck Series events, although these events drew much smaller crowds and generated significantly lower sponsorship, event-related, and broadcast television revenues compared to Sprint Cup events.

Dover Motorsports was one of three publicly traded racetrack operators, along with International Speedway Corporation (NASDAQ: ISCA) (“ISCA”) and Speedway Motorsports, Inc. (NYSE: TRK) (“SMI”). ISCA was controlled by members of the France family and SMI was controlled by O. Bruton Smith.

Motorsports Industry Overview

NASCAR

Founded by Bill France, Sr. in 1948, the National Association for Stock Car Auto Racing, Inc. (NASCAR) was the premier motorsports sanctioning body. NASCAR consisted of three national series (the NASCAR Sprint Cup Series, NASCAR Nationwide Series, and NASCAR Camping World Truck Series), a road racing series, and a variety of regional, local, and international racing series. The France family controlled the sanctioning body, and Brian Z. France served as CEO and Chairman of the Board of NASCAR.

By the fall of 2009, racetrack operations in the United States had begun to display many of the classic signs of sector maturity. Most significantly, nearly all of the country’s major media markets and population centers boasted an established NASCAR-affiliated track by this point, with the notable exception of New York City. Given the lack of de novo growth prospects and NASCAR’s outspoken reluctance to expand the current race schedule, profit-expansion opportunities were largely driven by more efficient marketing and management of tracks, offering enhanced experiences to race attendees, and successful acquisition and integration of competitors.

Pocono Raceway was owned by the Mattioli family with the asset held in a generation- skipping trust2, and the historic Indianapolis Motor Speedway, known for its open-wheeled racing, was owned by the George/Hulman family.

2 Speed Channel (6/13/04), reported by http://www.jayski.com

Corporate History

The Company was founded in 1969 as racetrack operator Dover Downs, and launched with a NASCAR Sprint Cup Series race won by Richard Petty. Dover Downs Entertainment, Inc., which included both the motorsports and gaming businesses, went public on the New York Stock Exchange in 1996 under the ticker symbol DVD. In 2002, the gaming portion of the Company’s operation was separated and went public on the New York Stock Exchange as Dover Downs Gaming & Entertainment, Inc. under the ticker symbol DDE. The Company’s motorsports operations were renamed Dover Motorsports, Inc. following the divestiture and retained the DVD ticker symbol. Despite the separation into two distinct businesses, the management teams of each company remained nearly identical.

Share Classes and Voting Structure

Dover Motorsports maintained a dual class share structure, which included common stock and Class A common stock. The Class A shares, owned by a small group of Rollins family members and management, carried ten votes per share. Common shares carried a single vote per share. Dividends on Class A shares could not exceed those of common shares, but under certain circumstances common dividends could exceed those of the Class A shares. In addition, the common and Class A common shares were part of a shareholder rights plan, also known as a “poison pill.” In the event that an outside investor accumulated over 10 percent of the company’s total shares, or tendered a takeover offer without prior approval, existing shareholders had the right to purchase additional shares in order to prevent a takeover.

RMT Trust

Following the death of John W. Rollins, Senior on April 4, 2000, Henry Tippie (at the time, Vice Chairman of Dover) was named executor of Mr. Rollins’ vast estate, and thereafter, Mr. Tippie possessed more than 50% voting control of the Company. The Last Will and Testament of John W. Rollins, Senior, established the RMT Trust as the primary vehicle to transfer assets to his wife, Michele M. Rollins. Among many of its stakes in property and operating assets, the RMT Trust held 8 million shares of Class A Common Stock in 2009, which represented approximately 39.4% of the voting control of Dover Motorsports. The Last Will and Testament stipulated that the RMT Trust would be administered by three trustees, presently Michele M. Rollins, R. Randall Rollins, and Henry B. Tippie. Through an agreement which renews annually, Michele Rollins and Randall Rollins yielded sole discretion over the voting power of shares held by RMT Trust to Henry Tippie. Therefore, at the behest of the Rollins, Henry Tippie maintained the dual role of Chairman of the Company and voting trustee of RMT Trust and was able to single-handedly determine the outcome of any and all shareholder votes. As the Company disclosed in its Annual Report:

“We are a controlled corporation because a single person…controls in excess of fifty percent of our voting power. This means he has the ability to determine the outcome of the election of directors at our annual meetings and to determine the outcome of many significant corporate transactions….Such a concentration of voting power could have the affect of delaying or preventing a third party from acquiring us at a premium.”

Business Overview

Key Executives

Henry B. Tippie, Chairman of the Board

Henry Tippie serves as Chairman of the Board of Dover Motorsports, as well as controlling Trustee of RMT Trust (Dover’s largest shareholder), and in these capacities exercises control over 54.4% of the combined voting power of the two classes of the Company’s common stock.

A Belle Plaine, Iowa farm boy, Henry B. Tippie enlisted in the United States Army Air Force at the age of 17, and enrolled at the University of Iowa upon completion of his military service. After earning his degree in Accounting in two years in 1949, Mr. Tippie pursued work as an accountant in Des Moines and Omaha, eventually earning his CPA in 1951. Shortly thereafter, he was hired by Delaware-based John W. Rollins, Associates as a controller. In his decades with the Rollins family and the diverse group of companies they control, Mr. Tippie has been instrumental in the growth and management of a number of firms across many unrelated industries.

For his many achievements in business, Mr. Tippie has been recognized with induction into the Horatio Alger Association of Distinguished Americans and has been the recipient of several distinguished alumni awards from the University of Iowa. In 1999, the University of Iowa renamed its College of Business Administration the Henry B. Tippie College of Business. The Henry B. Tippie College of Business was the first academic division of the University of Iowa to be named after an alumnus.

Mr. Tippie also serves as Chairman of the Board of Dover Downs Gaming & Entertainment and is a Director of three other public companies controlled by the Rollins family.

R. Randall Rollins, Director

In addition to his role as Trustee of RMT Trust and Director of Dover Motorsports and Dover Downs Gaming & Entertainment, Mr. Rollins was the Chairman of the Board of Rollins, Inc. (NYSE: ROL), Marine Products Corp. (NYSE: MPX), and RPC, Inc. (NYSE: RES) and maintained shared voting control of each of these public companies with his younger brother, Gary Rollins. As the eldest son of the late O. Wayne Rollins (brother of John W. Rollins, Senior) and as the sole Rollins family member involved with each of the five public companies controlled by the Rollins family, Mr. Rollins appeared to be the de-facto patriarch of the Rollins family.

Denis McGlynn, President, CEO and Director

Jeffrey W. Rollins, Director, son of John W. Rollins, Sr.

Kenneth K. Chalmers, Director

Patrick J. Bagley, Former CFO; Director

John W. Rollins, Jr., Director, son of John W. Rollins, Sr.

Eugene W. Weaver, Former SVP, Administration; Director

With the exception of Eugene Weaver, seven of the eight Directors of Dover Motorsports also served on the board of Dover Downs Entertainment. Mr. Tippie and Mr. McGlynn, maintained their respective directorships and/or management positions at Dover Downs Gaming & Entertainment as well, and received separate compensation from that entity.

DVD Directors – Overlap with Companies Controlled by the Rollins Family

Shareholder Concerns

Scale

Driving the consolidation wave of the late 1990’s through late 2000’s was Dover Motorsports’ largest competitor, International Speedway Corporation, or ISCA. Owning 13 active tracks, ISCA hosted 19 of the 36 NASCAR Sprint Cup Series races by 2009. By comparison, competitor Speedway Motorsports occupied a distant second place with eight racetracks, while Dover rounded out the third position with its four tracks and two Sprint Cup races. Consolidating a sizable portfolio of tracks and race dates under a single umbrella provided the leading players with sustainable competitive advantages in the form of superior ability to negotiate with NASCAR, lobby municipal and state governments and regulators, maintain pricing power for sponsorships and ticketing, and spread marketing and corporate expenses across a broader revenue base.

While the benefits of scale accrued to each of the top three market participants to some extent, International Speedway’s position as the industry leader had become increasingly difficult to challenge.

Dover Motorsports’ efforts to increase its size and competitive position, via both acquisitions and de novo expansion, were met with significant challenges. The 1998 acquisition of the Grand Prix Association of Long Beach for a pro-forma price of approximately $91 million included the Grand Prix of Long Beach, Gateway International Raceway and Memphis Motorsports Park. The Company later acquired the Grand Prix of Denver and Grand Prix of St. Petersburg and folded them into this business unit. These acquisitions resulted in a steady stream of asset impairments and goodwill writedowns of over $106 million between 2002 and mid-2009, and by 2005, only the Gateway and Memphis tracks remained part of Dover Motorsports.

In April 2001, Dover Motorsports inaugurated the Nashville Superspeedway, a 1.33 mile racetrack with a permanent seating capacity of 50,000, built at a cost of approximately $100 million (net of subsidies from the state of Tennessee). The facility was built for the purpose of attracting a NASCAR Sprint Cup Series race, which had yet to occur. In the 2009 NASCAR racing season, the Nashville Superspeedway played host to two NASCAR Nationwide Series races, the Pepsi 300 and Nationwide Auto Parts 300, and bore the unique distinction of being the only track to host two NASCAR Nationwide Series events without also hosting a Sprint Cup Series race.

By 2006, it was evident that Nashville would not attract a Sprint Cup series race, which resulted in nearly $20 million of asset impairments between 2006 and 2008.

In addition to the multitude of goodwill writedowns and asset impairments which occurred over the decade, it was believed that the Gateway, Memphis, and Nashville tracks collectively operated at a $5-$6 million annual loss and had never been profitable. An exact figure has never been available given the Company had never publicly provided any track level operating data or classified the Midwest assets as a separate operating unit.

Chairman Tippie’s business philosophy on cutting losses was highlighted in a 1999 interview from the Tippie School of Management at the University of Iowa.

“Being detail-oriented has always been important to me. I believe in getting all the facts, looking at different points of view, from different angles. It makes me a 24-hour “sleep on it” type of a decision-maker. I think it out, then go forward. If it doesn’t work, fine. I’m not one to stay with it if it doesn’t work– I cut my losses and try something else. I don’t let decisions keep me awake at night.”

“I’m probably at my best when things are toughest. When things get tough, I feel the need to organize and straighten things out. I’m strong on planning wherever I’m going. I’m also known as an ‘attack dog.’ I’m for attacking a problem, not running from it.”3

Declining Fundamentals

NASCAR experienced tremendous growth in popularity over a 15 year period, peaking at an estimated 75 million NASCAR fans in 2005. In the 2006 racing season, however, NASCAR began to experience declines in both television ratings and race attendance. Television ratings declined in 32 of 36 races, with declines of more than 10% for 16 of those races. In addition, NASCAR reports estimated that attendance decreased at a third of Sprint Cup races. At that time, it was estimated that fewer than half of the Sprint Cup races were sold out.45

The macro-economic fallout arising from the bursting of the United States’ housing bubble in 2007 continued to plague the consumer discretionary sector well into 2009. As a result, ticket demand for race events, corporate spending and sponsorship budgets, concession sales and other revenue streams generally remained soft across the motorsports industry, and Dover was no exception. Revenue and operating profit declines, which began in Fiscal 2006, had yet to reverse course. While the broad economic malaise affected Dover’s competitors as well, the Company’s lack of scale, its unprofitable tracks, and its reliance on a single facility (Dover) for its operating profit left the Company more vulnerable to undesirable economic conditions and underperformance. The reliance on a single track for its profits also subjected the Company to variability in results due to potential adverse weather conditions on its two Sprint Cup weekends per year.

Ticket sales presented a unique barometer for changing market conditions in the motorsports industry. Attendance at Dover International Speedway, never again sold out its 140,000 seated capacity, yet management continued to resist cutting ticket prices in 2009, opting instead to focus on package deals combining race admission, food and lodging.6 With 53% of NASCAR fans earning less than $50,000 annually, and 32% earning less than $30,000, many operators began to pay attention to what was becoming an increasingly elastic demand base.7 Competing racetracks aggressively cut prices in an attempt to revive volumes, with noteworthy examples such as Daytona International Speedway cutting grandstand prices to $40, the lowest level since 1996.8

The first wave of sponsorship terminations by corporate advertisers began in late summer and early fall 2008 with the abrupt exit of long-time supporters such as Chevron, General Motors and Chrysler. By July 2009, all four automobile manufacturers affiliated with the sport had reduced their support or announced plans to do so. Many of the sponsors who continued their involvement with NASCAR cut their commitments, forcing teams and track operators to seek multiple parties to split sponsorship deals.

While the early wave of sponsorship cancellations was weighted heavily towards the most beleaguered industries and marginal teams, by May 2009, speculation had begun that even brand-name players such as Jeff Gordon might be affected. Media sources were reporting that even DuPont chemical may not renew its NASCAR deal upon expiration, following other advertisers such as GM Goodwrench, Tide, Kodak, Jack Daniel’s and Jim Beam, among others.

Beyond the challenges faced by the prestigious Sprint Cup Series, the lower-tier events, such as the NASCAR Nationwide Series and Camping World Truck Series were hit even harder. With widespread sponsor exits and a number of teams sitting idle, industry observers are not convinced these lower tier series will survive in their current form over the intermediate term.

3 Business at Iowa, Henry Tippie Interview, Spring 1999

4 http://www.jayski.com/pages/tvratings2006.htm

5 USA Today, “NASCAR’s Growth Slows After 15 Years in the Fast Lane

6 Delaware News Journal, January 16, 2009

7 USA Today, “Tracks Go Extra Mile to Keep Fans Coming Back,” April 28, 2008

8 Revenues From Sports Venues, “Prices Drop for NASCAR Tickets in Daytona,” July 9, 2009

The slashing of corporate budget allocations to NASCAR, its raceways, races and teams led to multiplicative effects. As sponsor budgets fell, race teams were forced to cut their number of cars, number of races entered, merge with competitors, or cease operations altogether.

Many NASCAR track, event and team sponsors were in hard-hit sectors of the economy, such as automotive and construction. While some sponsorships were replaced by upstarts such as GoDaddy.com and Cash4Gold, serious questions remained about the ability of the industry to permanently replace lost revenue.

Transparency or Lack Thereof

The Company reported its financial results under a single operating segment, and did not disclose track-level information to any finer degree of granularity, making third-party analysis of the relative performance of various tracks a daunting task. The Company did not host an analyst day nor did its management participate in investor conferences. Dover Motorsports eliminated the Q&A portion of its quarterly earnings conference calls after the Q2 2008 event, eliminating the only public forum for shareholders to communicate with management. With no earnings guidance provided by the Company and minimal coverage provided by the equity research community, shareholders were seriously challenged to forecast future performance.

Failed Shift in Strategy

On January 28, 2009, Dover publicly announced it had entered into an agreement to sell Memphis Motorsports Park to Gulf Coast Entertainment, L.L.C. (“Gulf Coast”) for $10 million in cash, subject to financing conditions, with an expected closing date of April 30, 2009. Gulf Coast had announced its intention in September 2006 to build a major motorsports and entertainment facility in southern Alabama, with an initial expected completion date of fall 2009. By spring 2009, however, it became apparent that the financing for the Memphis acquisition might be at risk when Dover announced on April 24, 2009 that their agreement with Gulf Coast had been amended to provide for a closing on or before June 29, 2009. On July 8, 2009, Dover announced that Gulf Coast did not finalize its project financing in time for the scheduled June 29, 2009 closing date and further extended the closing date until September 29, 2009.

On September 30, 2009, the Company announced that its agreement to sell Memphis Motorsports Park to Gulf Coast had been terminated due to Gulf Coast’s inability to secure financing.

Public Market Valuation

From October 1, 2008 to October 1, 2009, Dover experienced a precipitous share price decline, falling nearly 72 percent, from $5.20 to $1.48 per share. This was more than double the percentage decline in the share prices of its two nearest competitors, International Speedway and Speedway Motorsports, whose share prices lost 30 percent and 26 percent, respectively.

While the $340 million price SMI paid for the New Hampshire International Speedway (a close comparable to Dover International Speedway) in 2008 may not be easily replicated in the environment of late 2009, even a fraction thereof would have eclipsed Dover’s total enterprise value, at that time, of roughly $91 million.

Investor Sentiment

By 2007, Dover’s outside shareholders had become increasingly concerned with the Company’s performance and strategy, voicing concerns about the Company’s prospects as a stand-alone entity. One of the most vocal shareholders was Marathon Partners, L.P., a New York City-based investment partnership founded by Mario Cibelli, the largest outside shareholder of the Company. In a series of letters addressed to Dover’s board of directors beginning in May 2007, Marathon articulated the concerns of Dover’s shareholders: namely, the Company’s weakened financial and operating position relative to its competitors and the resulting need to divest assets up to and potentially including the Company as a whole.

Marathon sent several letters to Dover’s board of directors during the period from 2007 to 2009. When Dover ultimately responded via letter on September 9, 2009, the Company’s General Counsel indicated that Dover had participated in merger talks with a consortium consisting of Speedway Motorsports and International Speedway, Dover’s primary competitors, on May 2, 2007. According to Dover Motorsports, the consortium offered to acquire Dover Motorsports for a five-cent per share premium to market value. Based on the May 1, 2007 adjusted closing price of $5.57, the stock went on to lose approximately seventy percent of its market value by late October 2009.

Voting Results of 2009 Annual Meeting

At the Company’s annual meeting which took place on April 29, 2009, shareholders voted on the re-election of three directors (including Mr. Tippie) and a stockholder proposal submitted by Marathon Partners to eliminate the Company’s poison pill.

Regarding Mr. Tippie’s re-election, 95.7 percent of the voting shares were cast in favor of Mr. Tippie’s re-election, with 4.3 percent of the votes being withheld. However, adjusting for the voting impact of the Class A shares, a very different result was apparent. Assuming all insiders had voted for the re-election of Mr. Tippie, the remaining non-insider votes would have totaled 65.2 percent withheld against Mr. Tippie’s re-election.

The number of “Withheld” votes related to the re-election of Chairman Tippie to the Board of Directors over his past three re-elections seemed to reflect a deterioration of support by outside shareholders.

Regarding the Stockholder Proposal, Marathon Partners argued in its supporting statement that the Rights Agreement served no other purpose than to arbitrarily limit the number of shares a current or prospective shareholder could own at 10% of the combined classes of stock.  Similar to the results of Mr. Tippie’s re-election, the vote of the non-insiders was drastically different than those of the insiders, with 90.7% of outside shareholders in favor of eliminating the poison pill.

Increasing Level of Shareholder Concern

Exchange Listing Warnings

On February 20, 2009, Dover Motorsports received a notice from the New York Stock Exchange indicating that it failed to meet the NYSE’s $75 million minimum market capitalization requirement and was in danger of being de-listed. On June 2, 2009, Dover received notice that it had regained compliance due to a reduction in minimum thresholds to $50 million. In early October of 2009, with a market capitalization of roughly $54 million, a mere 7.5 percent decline in the share price would once again put the Company in danger of being de-listed by the NYSE.

Suspension of Dividend

On July 29, 2009, Dover Motorsports announced that its Board of Directors voted to suspend the Company’s quarterly dividend on all classes of its common stock. As a result, Dover became the second Rollins-controlled public company in 2009 to suspend its regular dividend. The suspension of the dividend triggered the following salient provision in the Last Will and Testament of John W. Rollins, Senior.

“My wife shall have the power at any time and from time to time to require Trustee to convert any non income-producing property held at any time by the RMT to income producing property by delivering to Trustee a written direction to that effect.”9

Therefore, despite the Voting Agreement in force, the suspension of dividend enabled Ms. Rollins to compel Mr. Tippie to convert RMT Trust’s Dover shares from ‘non-income producing’ to ‘income producing’ at any time if so desired.

Debt Covenants

On August 21, 2009 the Company amended its revolving credit agreement with PNC Bank in order to avoid violating covenants attached to the revolver. As of the Company’s June 30, 2009 financial statements, $34.8 million was outstanding. The revised agreement increased interest rates on this facility to roughly LIBOR + 350 basis points, depending on certain external factors such as the current prime rate. In addition, the revised agreement granted the lender a lien on the Company’s assets and prohibited it from resuming its dividend.

Management Reticence to Discuss Sale

Setting itself apart from many companies which have wrestled with failed acquisitions and divestitures, concerns over debt repayment and de-listing notifications, Dover chose not to entertain any formal, public discussion of a potential sale process, nor did it publicly discuss the possibility of retaining an outside advisor to evaluate its options with respect to maximizing shareholder value. With the exception of CEO Denis McGlynn’s passing comment that “the Board has to look at [every potential offer]” during the Company’s July 24, 2008 earnings call (the Company’s final Q&A session), management had yet to publicly address the notion of a sale.

Management Non-Compete & Change in Control Provisions

As of the close of Fiscal Year 2008, the Company had $7.6 million to $9.2 million in contingent liabilities related to non-compete and change in control provisions relating to Dover’s senior management. Given the struggles endured by the Company, and subsequent evaporation of shareholder value, these agreements had appeared to become increasingly questionable. Independent observers may have wondered if a truly arms-length board would have continued to approve such agreements in the face of the Company’s ongoing challenges.

9 Last Will and Testament of John W. Rollins, Sr., paragraph 10(A)(1)

Strategic Alternatives

By October 2009, Dover Motorsports was at a crossroads with three simple options: it could maintain the status quo, continuing its present course of action and attempting to pay down debt out of cash flow; it could attempt to become a scale player through an acquisition or acquisitions, or it could retain a financial advisor and conduct a sales process.

Status Quo

Returning to profit growth via a “stay the course” strategy would first and foremost depend on a favorable macroeconomic environment. In the fall of 2009, industry observers expected headwinds to persist at least through 2010. Furthermore, the Company would need to sell its loss-generating business units in order to make more rapid progress on debt reduction and an eventual resumption of dividend payment. The failed sale of Memphis Motorsports Park to Gulf Coast Entertainment after nearly one year of public, and as much as three years of behind-the-scenes effort by the Company cast doubts on Dover’s ability to raise funds by selling any tracks except for its marquee asset, Dover International Speedway. With a strong likelihood of a continuing weak economic environment, incremental revenue and profitability expansion resulting from uplift in attendance, increased ticket prices and/or more favorable corporate sponsorship deals were becoming increasingly unlikely. In the event that NASCAR decided to reduce the number of races in future years, Dover Motorsports would potentially find itself at a disadvantage in its efforts to retain onto its Sprint Cup Series race weekends given its status as a small, independent operator.

During fiscal 2009, the Company was faced with a de-listing warning from the New York Stock Exchange which was only overcome due to a favorable change in requirements, and was forced to renegotiate its revolving credit agreement at less favorable terms when it appeared the Company would likely violate its debt covenants. Between these ongoing pain points, consolidation trends in the industry, and the Company’s position of weakness relative to its competitors, it was difficult to envision a scenario in which Dover Motorsports was capable of thriving as a stand-alone entity. By failing to articulate a forward-looking plan for a stand-alone Dover, management had done nothing to shed light on the viability of maintaining the status quo.

Acquisitions

Dover Motorsports had an extremely limited ability to pursue acquisitions due to a minimal cash position and diminished ability to fund acquisitions using debt. The Company’s experience with the Grand Prix Association of Long Beach cast doubts about its ability to successfully integrate an acquisition regardless of financing considerations.

Sale of Company

As the third largest public racetrack operator in the US, Dover Motorsports’ most credible potential acquirers were International Speedway Corporation and Speedway Motorsports. Each company had the financial and organizational capabilities to acquire and successfully integrate Dover Motorsports into a larger platform.

Potential Acquirers

International Speedway Corporation (“ISC”):

International Speedway Corporation was far and away the dominant racetrack operator in the US from the late-1990’s onward. In addition to its 13 racetracks, ISC was unique among track owners in the fact that its controlling shareholder, the France family, also owns the NASCAR organization. International Speedway had been a key partner of NASCAR in its attempt to expand and modernize the sport of automobile racing, and the two organizations have worked in tandem for over a decade to increase the number of high profile races and penetrate new media markets. NASCAR’s France family controlled more than two-thirds of the voting stock of International Speedway, and the two companies shared many of the same individuals among their executive ranks. While some of ISC’s competitors have alleged that this situation violated antitrust statutes, the courts had thus far shown little willingness to sever the relationship between these companies.

In early 2007, ISC acquired the remaining 62.5 percent of Raceway Associates it did not already own, giving it 100 percent of the Chicagoland Speedway and its Sprint Cup race weekend, for approximately $102 million. By acquiring nine tracks from 1999 to 2009, International Speedway demonstrated its competence at successfully valuing, purchasing, integrating and operating a nationwide portfolio of racetracks.

Speedway Motorsports Incorporated (“SMI”):

Speedway Motorsports Incorporated became the first publicly traded racetrack operator in the United States following its Initial Public Offering on the New York Stock Exchange in 1995. After pursuing a multi-year strategy of growth through the acquisition and closure of tracks in order to obtain NASCAR race dates, SMI operated eight racetracks by the fall of 2009. Speedway Motorsports boasts one of the largest permanent seat totals in the motorsports industry, and the highest average number of seats per raceway. In addition to its primary business of selling tickets to racing events, sponsorship and advertising placement and concessions sales, Speedway was also involved in the marketing and distribution of licensed and unlicensed souvenir and apparel merchandise and also operated a racing broadcast network through its Performance Racing Network subsidiary.

In January 2008, Speedway Motorsports closed on the $340 million acquisition of New Hampshire International Speedway, a racetrack with striking similarities to Dover International Speedway. Both facilities were home to two Sprint Cup race weekends, although New Hampshire International Speedway seats roughly 40,000 fewer attendees. Furthermore, New Hampshire International Speedway occupied a lower tier of TV revenue participation than the Dover racetrack for one of its two Sprint Cup races.

In December 2008, SMI closed on its acquisition of Kentucky Speedway for $78 million. Although it was designed with Sprint Cup Series events in similar fashion to Dover’s Nashville track, the facility did not host a Sprint Cup race weekend at the time it was purchased. Given Speedway’s objective of hosting one or two Sprint Cup race weekends at each of its qualified facilities, this transaction gave SMI a powerful incentive to obtain additional Sprint Cup races through an acquisition.

Transaction Rationale

A buyout offer could potentially arrive in the form of an all-stock offer at a premium to the Company’s current trading price, with a potential share repurchase designed to neutralize the dilutive effects of an all-stock transaction. Given recent retrenchments in the share prices of Dover’s two publicly-traded competitors, shareholders would derive additional upside in a subsequent recovery. Given the events of the first decade of the 21st century, it would be hard for any observer to conceive of a scenario in which Dover shareholders would be more successful as a standalone entity. Swapping Dover’s shares for those of a competitor who possessed a lower likelihood of underperforming the overall motorsports industry would mitigate any potential argument questioning the wisdom of what could be viewed as “selling at the bottom.”

Potential Obstacles

External obstacles to a transaction would be minimal. NASCAR demonstrated a willingness to endorse these roll-up acquisitions by transferring the race event sanction agreements to the acquirer. Both International Speedway and Speedway Motorsports have made no secret of their desire to acquire additional racetracks which host Sprint Cup Series events.

Internal obstacles to a transaction would be more formidable. The poison pill and non-compete agreements would need to be overcome before any possible transaction. Ultimately, the one and only relevant barrier to a Company-saving transaction appeared to be Mr. Tippie. His acquiescence would facilitate the board’s clear-headed assessment of the Company’s situation and realistic future progress, potentially forming an independent special committee and retaining an advisor.

Which Way Forward?

By all measures, the trajectory of Dover Motorsports under Mr. Tippie’s control left much to be desired. The remaining question for board members in 2009 was “What now?” Would the Company be best served by putting its future in the hands of a larger, stronger competitor, or by hoping to prevail in a battle of David versus two Goliaths?

If a board member felt a merger was the best course of action, how would he or she go about convincing Mr. Tippie that the history of Dover Motorsports and the jobs of its employees would be best secured through a merger, and that this transaction would be a fitting coda to an illustrious career spanning over six decades?

If, on the other hand, you elected to stay the course, how would you respond to concerns that you had neglected the concerns of the shareholders?

Given R. Randal Rollins role as a Director of Dover, a Trustee of RMT Trust (the largest shareholder), and apparent patriarch of the Rollins family, how might non-family board members attempt to convince Mr. Rollins to effect change at Dover?

How might Mr. Rollins best alter the current path of Dover given the long-standing relationship between Mr. Tippie and the Rollins family?

Subsequent Events

On October 30, 2009, the Company announced that it was ceasing all operations at Memphis Motorsports Park and that it would not promote any events in Memphis in 2010. Concurrently with the announcement, the Company announced it secured approval from NASCAR to realign the Memphis Nationwide Series race to Gateway International Raceway and the Camping World Truck Series race to Nashville Superspeedway.

On November 2, 2009, the Company reported its quarterly earnings for the period ended September 30, 2009. At that time, the Company disclosed that it made a further asset impairment charge of $7.5 million related to Memphis Motorsports Park.

On November 9, 2009, Marathon Partners sent a letter to the Trustees of RMT Trust, offering to acquire RMT Trust’s 8,000,000 shares of Class A common stock for $2.35 per share, a 35% premium to the day’s closing price of $1.75. While a sale of RMT Trust shares would not have resulted in Marathon Partners controlling the Company, it would have resulted in a shift of control from Mr. Tippie to other Rollins family members and management.

On November 17th, 2009, Mr. Tippie responded via letter to Marathon Partners indicating that the three Trustees of RMT Trust had no interest in pursuing Marathon Partners’ offer.

On November 25, 2009, Marathon Partners submitted a shareholder proposal to Dover Motorsports, seeking to amend the Bylaws of Dover to eliminate the transferability restrictions of Dover’s Class A Common Stock.

On December 1, 2009 Kansas Entertainment, LLC, a 50/50 joint venture between International Speedway and Penn National Gaming, was selected by the Kansas Lottery Gaming Facility Review Board to develop and operate a Hollywood-themed entertainment destination overlooking Turn 2 at ISCA’s Kansas Speedway, with a planned opening of 2012. Included within the joint venture’s winning proposal was ISCA’s commitment to add a second Sprint Cup race to Kansas Speedway in 2011.

On December 11, 2009, the United States Court of Appeals for the Sixth Circuit affirmed the lower court’s ruling in which it dismissed, in its entirety, the civil antitrust action brought by Kentucky Speedway, LLC against ISC and NASCAR. Jerry Carroll announced on behalf of the plaintiffs that the founding track ownership group will not exercise remaining legal options in the case of Kentucky Speedway, which largely cleared the way for SMI to move a Sprint Cup date to Kentucky Speedway as early as 2011.

Mr. Tippie was awarded an honorary doctorate from the University of Iowa at their December 19, 2009 commencement ceremonies. In the official University of Iowa press release dated December 3, 2009, Dean Curt Hunter describes Mr. Tippie as follows:

“Henry Tippie is a man of humble demeanor but extraordinary achievement, and he is a role model for University of Iowa students,” said Hunter. “He has built his businesses the right away [sic], with hard work and ethical considerations always foremost. His generosity with the University ensures that he will continue to inspire our students for generations to come.”10

10 http://tippie.uiowa.edu/news/story.cfm?id=2248

Although the information contained in this case study has been obtained from public sources that the author believes to be reliable, the author cannot guarantee its accuracy. The case study is for academic purposes only, and does not constitute an offer or solicitation to buy or sell any securities discussed herein. Marathon Partners, LP supported the costs of completing this study and had an investment interest in Dover Motorsports, Inc. as of the time of this writing.

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Farukh Farooqi, long-time supporter of Greenbackd, founder of Marquis Research, a special situations research and advisory firm (for more on Farukh and his methodology see The Deal in the article “Scavenger Hunter”) and Greenbackd guest poster (see, for example, Silicon Storage Technology, Inc (NASDAQ:SSTI) and the SSTI archive here) has launched a blog, Oozing Alpha. Says Farukh:

Oozing Alpha is a place to share event driven and special situations with the institutional investment community.

We welcome and encourage you to submit your top ideas (farukh@marquisllc.com).

The only limitation we impose is that your recommendations should not be widely covered by the sell side and must not have an equity market capitalization greater than $1 billion.

The ideas will no doubt be up to Farukh’s usual high standards. The blog is off to a good start: the color scheme is very attractive.

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