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We’ve been following Soapstone Networks Inc (SOAP.PK) since February 2nd this year (see our post archive here) because it was trading well below our estimate of its net cash value and an activist investor, Mithras Capital, had disclosed an 8.7% holding and called on the company to liquidate. After some urging, management acceded to the request and announced a liquidation. SOAP stockholders approved the liquidation of the company on July 28 and received a special dividend of $3.75 per share the next day. Based on our $2.50 purchase price, the $3.75 per share special dividend returned our initial capital plus 50%. At yesterday’s close, the $0.54 stub represents an additional 21% on our initial purchase price for a total return to date of 71%. Management estimates the final distribution will be between $0.25 and $0.75 per share, which means the stub is trading at a little over the $0.50 midpoint of the distribution range.

Since the payment of the $3.75 dividend, we’ve been grappling with the value of the stub. In an earlier post, Valuing the SOAP stub, we noted that two categories we’re key in estimating the final pay out figure because they accounted for the majority (80%) of the difference between the upper and lower estimates of the final distribution. Those two categories were:

1. Real Estate and Equipment Lease termination costs: The lower bound of the range is -$5.4M and the upper bound is -$1.6M, which is a difference of around $3.8M or $0.25 per share.
2. Proceeds from the sale of Assets: The lower bound of the range is $0.1M and the upper bound is $2.3M, which is a difference of around $2.2M or $0.14 per share.

SOAP has announced the sale of its software assets to Extreme Networks, Inc. (NASDAQ: EXTR). The sale price was not disclosed in the announcement, but was less than $5M. If the sale price is in fact closer to $5m, SOAP management seems to have significantly underestimated the range for Proceeds from the sale of Assets. At its close yesterday of $0.54, the SOAP stub might become an attractive investment opportunity if we can get some certainty around the actual figure for the proceeds from the sale of the software assets. Wes Gray and Andrew Kern, who provided the earlier post on CombiMatrix Corporation (NASDAQ:CBMX), have a view on the value of the SOAP stub:

Soapstone Networks (SYMBOL: SOAP.PK) is a liquidation play with a relatively short investment horizon and decent return. We believe the liquidation stub has solid downside protection and can likely return 50%+ by Q4 2010, with a potential to return over 100%.

Valuation

a. DEF 14A Management Liquidation Estimates

On July 2, 2009 management filed a DEF 14A. On page 30 there is a table outlining their liquidation estimates for the company. They estimate the range for the large initial distribution to be between .25 and .75. Below are management’s estimates:

b. Fast forward to September 1, 2009

The estimates of liquidation value in the DEF 14A may have been good at the time, but the situation has certainly changed for the better. I’ll go through each line that has major changes or updates. You can call the CFO to confirm this information at 978-715-2300 and ask for Bill Stuart.

1) Proceeds from sale of Assets

Soapstone has 3 categories of assets: (i) IP from PNC software, (ii) IP from their older projects, and (iii) the physical equipment and property located at One Federal Street, Billerica, MA 01821.

(i) On August 10, 2009 Soapstone announced they sold Soapstone’s core technology for an undisclosed amount “at less than $5mm” according to the EXTR CEO.

(ii) We have no real feel for how much SOAP’s portfolio of remaining IP is worth, but the CFO says it certainly isn’t worth $0.

(iii) No clue what the equipment/computers/servers/etc in the building are worth, but it is also probably worth more than zero, even in a fire-sale.

Conclusion: 100k certainly seems a bit too low to us, and $2.3mm may be a little on the high side. However, our research indicates that EXTR would have been extremely happy to purchase SOAP’s software for $3mm+.

Low estimate: EXTR gets steal of the century and purchases IP for 100k, (ii) and (iii) are worth 0.

Expectation: EXTR buys IP for 1.8mm, (ii) worth 100k, (iii) worth 100k, total is $2mm

High estimate: $2.3mm

2) Operating Expenses after June 30, 2009

The DEF 14 estimates for operating expenses are pegged at $2mm. This is ludicrous given what has happened since that estimate (at the time they were expecting to run a shop of 30+ employees for at least a year). As of August 31, the company has 6 remaining employees and according to the CFO they are “downsizing very fast and trying to wrap up operations by Q4 2009.”

Conclusion: The $2mm estimate is no longer applicable given the current situation at SOAP.

Low Estimate: The CFO goes nuts and burns money on the weekends: -$2mm

Expectation: By end of September SOAP is left with the accountant, a clerk, and the CFO, but company still burns money for fun. -$1mm

High Estimate: CFO runs a lean ship and things go ahead as scheduled: -$250k

3) Real Estate and Equipment Lease termination costs

The DEF 14 estimates these expenses to range from -$5.4mm to -$1.6mm. These figures include the actual lease obligations ($3.728mm as of June 30, 2009, page 20 on the 10Q) and operating expenses associated with the leases (taxes passed through by building owner and maintenance charges). The $5.4mm figure assumes they stay in the building until 2014 and eat 100% of the costs. This is NOT going to happen. The building is already aggressively being marketed and the CFO expects to get out of the actual lease at 50% fairly easily. While the commercial RE market in the area is very weak, a lease buyout at a large discount is very possible.

Conclusion: Lots to gain here…

Low Estimate: CFO sits in the building for 6 months and has the lease bought out at 25% (i.e. someone gets the deal of the century): -3.30mm

Expectation: SOAP eats 150k more in taxes/maintenance charges and gets out with a 50% buyout of lease in the next 3-6 months. -$2mm

High Estimate: SOAP gets out of lease with 60% buyout and eats 150k in taxes/maintenance charges in the next 3-6 months: -$1.6mm

4) Professional Fees

The DEF 14 estimates these expenses to range from -$2.7mm to -$2.2mm. As of August 31, 2009 the CFO says they have spent about $1mm and expect to spend about that much going forward (conservative estimate).

Conclusion: Potential to save a bit here.

Low Estimate: -$2.7mm

Expectation: -$2.2mm

High Estimate: -$2mm

c. How estimates look after accounting for what has happened since the original liquidation estimates

With a current stock price of .48 the low estimate of .39 translates into -18.1%, we expect .7, which is a 45.48%, and it is very possible we end up with .82 or a 71.86% return.

d. Second distribution

The CFO says that it is likely that they will have remaining IP and assets for sale after the initial distribution and the reserve for unanticipated claims and contingencies will be distributed Q4 2010.

Low Estimate: 0 from assets, $1mm from 1.8mm contingency => .06/s distro

Expectation: 0 from assets, $1mm from $1.8mm contingency => .06/s distro

High Estimate: $.5mm from assets, $1.8mm from $1.8mm contingency => .15/s distro

e. Total Return Possible

Low Estimate: .39 first distribution (Q2 2010), .06 second distribution (Q4 2010)

=>-4.57%

Expectation: .70 first distribution (Q1 2010), .06 second distribution (Q4 2010)

=>59.01%

High Estimate: .82 first distribution (Q4 2009), .15 second distribution (Q4 2010)

=>102.98%

Expected Return:

P(Low)=.25

P(Estimate)=.50

P(High)=.25

ð .25*-.0457+.50*.5901+.25*1.0298=54.11% expected return by Q4 2010.

Catalyst

1. Asset sale announcements

2. Lease buyout announcements

3. Liquidation payments

[Full Disclosure:  We have a holding in SOAP. 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.]