Greenbackd

Ditech Networks Inc (NASDAQ:DITC) is a stock trading well below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. At yesterday’s closing price of $0.89, the company has a market capitalization of $23.3M. We estimate the net cash value to be more than 60% higher at $37.9M or $1.44 per share. Lamassu has offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” We’re adding DITC to the Greenbackd Portfolio.

About DITC

DITC is a global telecommunications equipment supplier for voice networks. Its products include echo cancellers, which are used to eliminate echo in voice networks. The company’s investor relations website is here.

The value proposition

The company’s most recent 10Q tells a horrifying story. The company is consistently burning cash in its operations and burned through more than $8M in the six months to October 31 last year. A substantial (but dwindling) amount of cash remains on the balance sheet (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):

Off-balance sheet arrangements and Contractual obligations

According to the 10Q, DITC has around $6.2M in contractual commitments (including $2.9M in operating leases and $3.2M in purchase commitments), around $3.7 of which falls due this year and the remainder falling due within the next 3 years. DITC has no other material commitments.

The catalyst

Lamassu’s amended 13D notice attached the following letter:

January 28, 2009

Todd Simpson
CEO
Ditech Networks, Inc.
825 East Middlefield Road
Mountain View, CA 94043

Mr. Simpson and Ditech Board of Directors:

I am writing this letter to ask for your support in the acquisition of Ditech Networks by AccessData. Because AccessData is a portfolio company of Lamassu Holdings and Lamassu is a 10% owner of Ditech, the company’s poison pill precludes AccessData from officially offering to purchase the company. That said AccessData is interested in acquiring all of Ditech Networks for $1.25 per share
in cash. We would like to move forward as quickly as possible. We anticipate our due diligence requirement will take no more than two weeks and we have no financing contingency.

We strongly believe an acquisition by AccessData, at a premium to market, will result in the best outcome for all shareholders, including ourselves. We have reached this conclusion after analyzing other alternatives including a liquidation, an acquisition or staying the current course of new product
development. In a liquidation, the cash returned to shareholders could vary greatly depending on certain assumptions, but I doubt you would disagree that there is a reasonable probability this return would be below $1.25.

When we look at acquisitions or new product development as an option, we are discouraged by past performance of the Ditech organization in several attempts. While Mr. Simpson is relatively new as CEO, the Board is not. And, while I was not a shareholder over the last 9 years the company has been public, I can still use past performance to evaluate this Board’s efficacy. For this I do not need
to look much beyond the balance sheet. Retained earnings are a loss of over $194MM. So over its life, this company has lost nearly $200MM. When examined more closely, it is surprising to learn that the company had a very profitable echo cancellation product line that generated substantial profits over this time. It appears most of the money was squandered through attempts to diversify the business. There are three glaring examples of failed diversification attempts: 1) the optical systems effort that was discontinued after costing the company nearly $80MM by some accounts, 2) the Jasomi acquisition, which cost $24MM and appears to have little to no contribution to the business, and 3) the PVP development, which has yet to generate significant revenue.

After reviewing the failure of nearly every major effort to diversify the company, it does not surprise me that the current valuation is significantly below the net cash of the company. The company is faced with reinventing itself, which may be more successful with Mr. Simpson as CEO, but most of the players involved with past failures remain the same. It is clear to me that shareholders are voting by selling stock well below the net cash value and tangible book value.

I do see value in the company’s balance sheet and its technology, however, I do not believe that the right course of action for me is to wait and see if the business can be reinvented. I believe the likelihood of a successful investment for myself and other shareholders increases greatly if Ditech is acquired by AccessData which will both diversify the business and utilize overhead (legal, audit, G&A) more efficiently.

I would like an opportunity to meet with the Board either in person or telephonically in the immediate future to discuss my offer. I sincerely hope the management and Board will address my offer immediately and move quickly to reach a consensus. Based on last quarter’s results it appears the company is losing nearly $400,000 per week, so clearly time is of the essence.

Sincerely,

Tim Leehealy

Conclusion

We love a stock trading at a discount to net cash. At its $0.89 close yesterday, DITC’s net cash value is more than 60% higher. There is a good reason for DITC to trade at such a discount, but we think there is also a good chance that Lamassu can make its $1.25 offer and realise some of that value for stockholders.

DITC closed yesterday at $0.89.

The S&P500 Index closed yesterday at 788.42.

[Full Disclosure:  We do not have a holding in DITC. 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.]