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Archive for the ‘Audiovox Corporation (NASDAQ:VOXX)’ Category

In the Spring 1999 Piper Jaffray produced a research report called Wall Street’s Endangered Species by Daniel J. Donoghue, Michael R. Murphy and Mark Buckley, then at Piper Jaffray and now at Discovery Group, a firm founded by Donoghue and Murphy (see also Performance of Darwin’s Darlings). The premise of the report was that undervalued small capitalization stocks (those with a market capitalization between $50M and $250M) lacked a competitive auction for their shares and required the emergence of a catalyst in the form of a merger or buy-out to close the value gap.

In the first follow-up, Endangered species update: The extinct, the survivors, and the new watch list, from Summer 2000, Murphy and Buckley (Donoghue is not listed on the 2000 paper as an author) tested their original thesis and provided the “Darwin’s Darlings Class of 2000,” which was a list of what they viewed as “the most undervalued, yet profitable and growing small cap public companies” in 2000.

In the Fall of 2001, Donoghue, Murphy, Buckley and Danielle C. Kramer produced a further follow-up to the original report called Endangered Species 2001 (.pdf). Their thesis in the further follow up should be of particular interest to we value folk. Putting aside for one moment the purpose of the report (M&A research aimed at boards and management of Darwin’s darlings stocks to generate deal flow for the investment bank), it speaks to the very fertile environment for small capitalization value investing then in existence:

In the last few of years, many small public companies identified this [secular, small capitalization undervaluation] trend and agreed with the implications. Executives responded accordingly, and the number of strategic mergers and going-private transactions for small companies reached all-time highs. Shareholders of these companies were handsomely rewarded. The remaining companies, however, have watched their share prices stagnate.

Since the onset of the recent economic slowdown and the technology market correction, there has been much talk about a return to “value investing.” Many of our clients and industry contacts have even suggested that as investors search for more stable investments, they will uncover previously ignored small cap companies and these shareholders will finally be rewarded. We disagree and the data supports us:

Any recent increase in small-cap indices is misleading. Most of the smallest companies are still experiencing share price weakness and valuations continue to be well below their larger peers. We strongly believe that when the overall market rebounds, small-cap shareholders will experience significant underperformance unless their boards effect a change-of-control transaction.

In this report we review and refresh some of our original analyses from our previous publications. We also follow the actions and performance of companies that we identified over the past two years as some of the most attractive yet undervalued small-cap companies. Our findings confirm that companies that pursued a sale rewarded their shareholders with above-average returns, while the remaining companies continue to be largely ignored by the market. Finally, we conclude with our third annual list of the most attractive small-cap companies: Darwin’s Darlings Class of 2001.

Piper Jaffray’s data in support of their contention is as follows:

Looking back further than just the last 12 months, one finds that small-cap companies have severely lagged larger company indices for most periods. Exhibit II illustrates just how poorly the Russell 2000 compares to the S&P 500 during the longest bull market in history. In fact over the past five, seven and ten years, the Russell 2000 has underperformed the S&P 500. For the five, seven and 10 year periods, the S&P 500 rose 82.6 percent, 175.6 percent and 229.9 percent, respectively, while the Russell 2000 rose 47.9 percent, 113.4 percent, and 206.3 percent for the same periods.

The poor performance turned in by the Russell 2000 can be attributed to the share price performance of the smallest companies in the index. Our previous analysis has shown that the smallest companies in the index have generally underperformed the larger companies (see “Wall Streets Endangered Species,” Spring 1999). To understand the reasons for this differential, one must appreciate the breadth of the index. There is a tremendous gap in the market cap between the top 10 percent of the companies in the index, as ranked by market cap (“the first decile”) and the last 10 percent (“the bottom decile”). The median market capitalization of the first decile is $1.7 billion versus just $201.0 million for the bottom decile. There is almost an 8.0x difference between what can be considered a small cap company.

This distinction in size is important, because it is the smallest companies in the Russell 2000, and in the market as a whole, that have experienced the weakest share price performance and are the most undervalued. Exhibit III illustrates the valuation gap between the S&P 500 and the Russell 2000 indices. Even more noticeable is the discount experienced by the smallest companies. The bottom two deciles of the index are trading at nearly a 25 percent discount to the EBIT multiple of the S&P 500 and at nearly 40 percent below the PIE multiple on a trailing 12-month basis.

This valuation gap has been consistently present for the last several years, and we fully expect it to continue regardless of the direction of the overall market. This differential is being driven by a secular trend that is impacting the entire investing landscape. These changes are the result of:

• The increasing concentration of funds in the hands of institutional investors

• Institutional investors’ demand for companies with greater market capitalization and liquidity

• The shift by investment banks away from small cap-companies with respect to research coverage and trading

The authors concluded that the trends identified were “secular” and would continue, leading small capitalization stocks to face a future of chronic undervaluation:

Removing this discount and reviving shareholder value require a fundamental change in ownership structure. Equity must be transferred out of the hands of an unadoring and disinterested public and into those of either: 1) managers backed by private capital, or 2) larger companies that can capture strategic benefits. Either remedy breathes new life into these companies by providing cheaper sources of equity capital and shifting the focus away from quarterly EPS to long-term growth.

They recognized the implications for secular undervaluation which lead them to make an impressive early identification of the re-emergence of modern shareholder activism:

Unfortunately, many corporate executives continue to believe that if they stick to their business plan they will eventually be discovered by the financial community. Given the recent trends, this outcome is not likely. In fact, there is a growing trend toward shareholder activism to force these companies to seek strategic alternatives to unlock shareholder value. Corporate management is now facing a new peril – the dreaded proxy fight. Bouncing back from their lowest level in more than a decade, proxy fights have increased dramatically thus far in 2001 and are running at nearly twice the pace as they were last year, according to Institutional Shareholder Services. In fact, not since the late 1980s has there been such attention devoted to the shareholder activism movement.

As shown in our Darwin’s Darlings list in Exhibit XX, page 23, management ownership varies widely among the typical undervalued small cap. For those that were IPOs of family-held businesses, management stakes are generally high. In these instances in which a group effectively controls the company, there will be little noise from activist shareholders. However, companies with broad ownership (i.e., a spinoff from a larger parent) are more susceptible to unfriendly actions. In fact, widely held small caps frequently have blocks held by the growing number of small-cap investment funds focused on likely takeover targets.

Regardless of ownership structure, these companies typically have the customary defensive mechanisms in place. They are also protected because they are so thinly traded. In most cases it can take more than six months to accumulate a 5 percent position in the stock without impacting the share price. While we expect most of the successful acquisitions in this sector to be friendly, small-cap companies will have to increasingly worry about these unfriendly suitors.

There are several consistent factors that are driving the increased frustration among shareholders and, consequently, the increased pressure on Management and Boards. These factors include the aforementioned depressed share prices, lack of trading liquidity, and research coverage. But also included are bloated executive compensation packages that are not tied to share price performance and a feeling that corporate boards are staffed with management allies rather than independent-minded executives. Given the continuing malaise in the public markets, we believe this heightened proxy activity will continue into the foreseeable future. Companies with less than $250 million in market capitalization in low growth or cyclical markets are the most vulnerable to a potential proxy battle, particularly those companies whose shares are trading near their 52-week lows.

Here they describe what was a novelty at the time, but has since become the standard operating procedure for activist investors:

Given the growing acceptance of an aggressive strategy, we have noticed an increase in the number of groups willing to pursue a “non-friendly” investment strategy for small caps. Several funds have been formed to specifically identify a takeover target, invest significantly in the company, and force action by its own board. If an undervalued small cap chooses to ignore this possibility, it may soon find itself rushed into a defensive mode. Thwarting an unwanted takeover, answering to shareholders, and facing the distractions of the press may take precedence from the day-to-day actions of running the business.

So how did the companies perform? Here’s the chart:

Almost 90 percent of the 1999 class and about half of the 2000 class pursued some significant strategic alternative during the year. The results for the class of 1999 represent a two-year period so it is not surprising that this list generated significantly more activity than the 2000 list. This would indicate that we should see additional action from the class of 2000 in the coming year.

A significant percentage (23 percent of the total) pursued a sale or going-private transaction to provide immediate value to their shareholders. Others are attempting to “grow out of” their predicament by pursuing acquisitions and many are repurchasing shares. However, many of Darwin’s Darlings have yet to take any significant action. Presumably, these companies are ignoring their current share price and assuming that patient shareholders will eventually be rewarded through a reversal in institutional investing trends, or perhaps, in a liquidity event at some later date.

The actual activity was, in fact, even greater than our data suggests as there were many transactions that were announced but failed to be consummated, particularly in light of the current difficult financing market. Chase Industries, Lodgian, Mesaba Holdings, and Chromcraft Revington all had announced transactions fall through. In addition, a large number of companies announced a decision to evaluate strategic alternatives, including Royal Appliance, Coastcast, and Play by Play ‘Toys.

The authors make an interesting observation about the utility of buy-backs:

For many of Darwin’s Darlings and other small-cap companies, the share repurchase may still have been an astute move. While share price support may not be permanent, the ownership of the company was consolidated as a result of buying in shares. The remaining shareholders were, in effect, “accreted up” in their percentage ownership. When a future event occurs to unlock value, these shareholders will reap the benefits of the repurchase program. Furthermore, the Company may have accommodated sellers desiring to exit their investment, thereby eliminating potentially troublesome, dissenting shareholders. There are circumstances when a repurchase makes good sense, but it should not be considered a mechanism to permanently boost share prices.

Piper Jaffray’s Darwin’s Darlings Class of 2001, the third annual list of the most attractive small-cap companies, makes for compelling reading. Net net investors will recognize several of the names (for example, DITC, DRAM,  PMRY and VOXX) from Greenbackd and general lists of net nets in 2008 and 2009. It’s worth considering that these stocks were, in 2001, the most attractive small-capitalization firms identified by Piper Jaffray.

See the full Endangered Species 2001 (.pdf) report.

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Audiovox Corporation (NASDAQ:VOXX) has filed its 10K for the fiscal year ended February 28, 2009.

The stock has risen strongly over recent weeks to close yesterday at $5.93, which gives VOXX a market capitalization of $135.6M. We’ve had an opportunity to review the 10K, and we’ve now slightly reduced our estimate of VOXX’s liquidation value to $117.3M or $5.13 per share. With the stock trading at a premium to our estimate of liquidation value, we’ve decided to exit. We opened the position at $3.73, and the stock closed yesterday at $5.93, which means we’re up 59.0% on an absolute basis. The S&P500 Index closed at 789.17 on the day we opened the position in VOXX and closed yesterday at 909.71, which means we’re up 43.7% on a relative basis.

Post mortem

We started following VOXX (see the post archive here) because it was a profitable, undervalued asset play. When we opened the position, we estimated VOXX’s liquidation value to be around $128.4M or $5.60 per share against a share price of $3.73 and a market capitalization of $85.3M. Howson Tattersal had filed a 13D notice in September last year disclosing a 7.3% holding. We noted that, while VOXX was a perennial inclusion on lists of net-net stocks, we thought it hard to ignore at $3.73. Fast forward to today. The stock is up 59% to $5.93 and the liquidation value is down slightly to $5.13 per share. The updated balance sheet is set out below (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):

VOXX Summary 2009 2 28Balance sheet adjustments

  • Cash generation: The company generated $30.0M in operating cash flow in the last year.
  • Off-balance sheet arrangements and contractual obligations: According to its most recent 10K, VOXX does not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon its financial condition or results of operations.VOXX has around $43.4M in contractual cash obligations (including $11M in capital lease obligations and $32M in operating leases), around half of which falls due in the next 5 years and $24.0M falling due after 5 years. VOXX also has another $62M in unconditional purchase obligations falling due in the next 12 months.

Conclusion

We are again reasonably happy with the outcome in VOXX. While Howson Tattersall’s campaign has not been run to its conclusion, we feel that with the stock trading at a premium to VOXX’s liquidation value, and with VOXX’s liquidation value reducing over the last quarter, it is an opportune time to exit.

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

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Greenbackd Portfolio Q1 performance and update

March 1, 2009 marked the end of Greenbackd’s first quarter, so we thought we’d take the opportunity to update you on the performance of the Greenbackd Portfolio and the positions in the portfolio, discuss some changes in our valuation methodology since our first post and outline the future direction of Greenbackd.com.

First quarter performance of the Greenbackd Portfolio

We get many questions about the content and performance of the portfolio. We had originally planned to report on a six-monthly basis, but we have now decided to report on a quarterly basis so that we can address these questions on a more frequent basis. Although it is still too early to determine how Greenbackd’s strategy of investing in undervalued asset situations with a catalyst is performing, we’ve set out below a list of all the stocks we’ve included in the Greenbackd Portfolio and the absolute and relative performance of each at the close on the last trading day in our first quarter, Friday, February 28, 2009:

greenbackd-portfolio-performance-2009-q13The absolute total return across the current and former positions as at February 28, 2009 was -3.7%, which was +7.0% higher than the S&P500’s return over the same periods. A negative return for the first period is disappointing, but we are heartened by the fact that we outperformed the market by a small margin.

You may have noticed something odd about our presentation of performance. The S&P500 index declined by 18.0% in our first quarter (from 896.24 to 735.09). Our -3.7% performance might suggest an outperformance over the S&P500 index of +14.3%. We calculate our performance on a slightly different basis, recording the level of the S&P500 index on the day each stock is added to the portfolio and then comparing the performance of each stock against the index for the same holding period. The Total Relative performance, therefore, is the average performance of each stock against the performance of the S&P500 index for the same periods. As we discussed above, the holding period for Greenbackd’s positions has been too short to provide any meaningful information about the likely performance of the strategy over the long term (2 to 5 years), but we believe that the strategy should outperform the market by a small margin.

Greenbackd’s valuation methodology

We started Greenbackd in an effort to extend our understanding of asset-based valuation described by Benjamin Graham in the 1934 Edition of Security Analysis. Through some great discussion with our readers, many of whom work in the fund management industry as experienced analysts or even managing members of hedge funds, we have had the opportunity to refine our process. We believe that what started out as a pretty unsophisticated application of Graham’s liquidation value methodology has evolved into a more realistic analysis of the balance sheet and the relationship of certain disclosures in the financial statements to asset value. We’re not yet ready to send it into space, but we believe our analyses are now qualitatively more robust than when we started and that has manifest itself quantitatively in better performance (more on this below).

The two main differences between our early analyses and our more recent ones are as follows (these are truly cringe-worthy, but that’s why we undertook the exercise):

  1. We didn’t take account of the effect of off-balance sheet arrangements and contractual obligations. This caused us to enter into several positions we should have avoided, including BGP and VVTV.
  2. We were using overly optimistic estimates for the recovery rates of assets in liquidation. For example, we started using 50% of Gross PP&E. We now use 20% of Net PP&E. We now apply Graham’s formula as the base case and deviate only when we believe that Graham’s formulation doesn’t reflect reality.

The effect of these two broad errors in analysis was to create several “false positives,” which is to say that we added stocks to the portfolio that wouldn’t have passed our current, more rigorous standards. The performance of those “false positive” stocks has been almost uniformly negative, and dragged down the performance of the portfolio. As an exercise, we went back through all the positions we have opened since we started the site and applied our current criteria, which are more stringent and dour than our earlier standards. We found that we would not have opened positions in the following eight stocks:

  • BRN (-13.1% on an absolute basis and +4.9% on a relative basis)
  • BGP (-10.8% on an absolute basis and -21.6% on a relative basis)
  • COBR (-17.1% on an absolute basis and +3.6% on a relative basis)
  • HRT (-25.3% on an absolute basis and -9.7% on a relative basis)
  • KONA (+87.8% on an absolute basis and +81.9% on a relative basis)
  • MGAM (-24.2% on an absolute basis and -5.0% on a relative basis)
  • VVTV (-25.0% on an absolute basis and -23.1% on a relative basis)
  • ZLC (-72.0% on an absolute basis and -61.1% on a relative basis)

It seems we got lucky with KONA, but the performance of the balance of the stocks was wholly negative. The performance across all stocks listed above was -12.5% on an absolute basis and -3.9% on a relative basis. Excluding these eight stocks from our portfolio (i.e. treating the portfolio as if we had not entered into these positions) would have resulted in a slightly positive absolute return of +0.7% and a relative performance over the S&P500 of +12.5%. This is a compelling reason to apply the more dour and rigorous standards.

We like to think we’ve now learned out lesson and the more dour and rigorous standards are here to stay. Set out below is an example balance sheet summary (for Chicago Rivet & Machine Co. (AMEX:CVR)) showing our present base case discounts from book value (circled in red):

example-summary-2

Readers will note that these are the same base case discounts from book value suggested by Benjamin Graham in the 1934 Edition of Security Analysis, more fully described in our Valuing long-term and fixed assets post under the heading “Graham’s approach to valuing long-term and fixed assets.” Why we ever deviated from these standards in the first place is beyond us.

Update on the holdings in the Greenbackd Portfolio

Leading on from our discussion above, four of the stocks we picked using the initial, overly optimistic criteria no longer meet our more stringent standards but haven’t yet been removed from the portfolio. We’re going to take our medicine now and do just that. To make it clear, these stocks aren’t being removed because the value has deteriorated, but because we made a mistake adding them to the portfolio in the first place. As much as we’d like to treat these positions as void ab initio (“invalid from the beginning”), we’re not going to do that. We’ve made a full accounting of the impact they’ve had on the portfolio in the First quarter performance of the Greenbackd Portfolio section above, but we don’t want them affecting our future performance. The stocks to be removed from the Greenbackd Portfolio and their absolute and relative returns are as follows:

  • BRN (-13.1% on an absolute basis and +4.9% on a relative basis)
  • HRT (-25.3% on an absolute basis and -9.7% on a relative basis)
  • MGAM (-24.2% on an absolute basis and -5.0% on a relative basis)
  • COBR (-17.1% on an absolute basis and +3.6% on a relative basis)

We’ll provide a more full discussion of where we went wrong with these stocks at a later date, but suffice it to say for present purposes that all were errors from the second bullet point in the Greenbackd’s valuation methodology section above (i.e. overly optimistic estimates for the recovery rates of assets in liquidation).

There are fifteen stocks remaining in the Greenbackd Portfolio:

Eight of these positions (ABTL, ACLS, ARCW, CAPS, CRC, CRGN, NSTR, and VOXX) are trading at or below our nominal purchase price and initial valuations. The remaining seven positions (AVGN, DITC, IKAN, MATH, NENG, NTII, and SOAP) are trading above our intial purchase price but are still at varying discounts to our valuations. We’ll provide a more full update on these positions over the course of this week.

The future of Greenbackd.com

We are going to trial some small changes to the layout of the site over the next few weeks. We’ve already made the first change: the newest comments now appear at the top of the list. We’ll also be amalgamating some pages and adding some new ones, including a page dedicated to tracking the portfolio with links to the analyses. We’re also considering some options for generating income from the site. At the moment, Greenbackd is a labor of love. We try to create new content every week day, and to get the stock analyses up just after midnight Eastern Standard Time, so that they’re available before the markets open the following day. More than 80% of the stocks that are currently trading at a premium to the price at which we originally identified them (NTII, SOAP, IKAN, DITC, NENG, MATH and AVGN) traded for a period at a discount to the price at which we identified them. This means that there are plenty of opportunities to trade on our ideas (not that we suggest you do that). If you find the ideas here compelling and you get some value from them, you can support our efforts by making a donation via PayPal.

We look forward to bringing you the best undervalued asset situations we can dig up in the next quarter.

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Audiovox Corporation (NASDAQ:VOXX) is a rarity in our universe: a profitable undervalued asset play. At its $3.73 close yesterday, VOXX has a market capitalization of $85.3M. We estimate the liquidation value to be 50% higher at around $128.4M or $5.60 per share. Howson Tattersal filed a 13D notice in September last year disclosing a 7.3% holding. While VOXX has been another perennial inclusion on lists of net-net stocks, we think it’s hard to ignore at this price.

About VOXX

VOXX is an “international distributor and value-added service provider in the accessory, mobile and consumer electronics industries.” The company markets its products under the Audiovox brand name and other brand names, including Acoustic Research, Advent, Ambico, Car Link, Chapman, Code-Alarm, Discwasher, Energizer, Heco, Incaar, Jensen, Mac Audio, Magnat, Movies2Go, Oehlbach, Phase Linear, Prestige, Pursuit, RCA, RCA Accessories, Recoton, Road Gear, Spikemaster and Terk, as well as private labels through a domestic and international distribution network. See the company’s website here. The company’s investor relations website is here.

The value proposition

VOXX’s sales, operating income and net income increased in the quarter ended November 30, 2008. Net sales for the third quarter were $195.6 million compared to net sales of $183.6 million reported in the comparable prior year period. Operating income was $10.7 million in the third quarter compared to $6.7 million in the preceding third quarter. Net income was $6.5 million compared to net income of $4.7 million in the comparable period. This doesn’t tell the full story however as operating activities used cash of $26.7M for the nine months ended November 30, 2008. The company used less cash for its operating activities compared to the prior year period ($92.9M), but it is still a concern for us. The balance sheet looks interesting (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):

voxx-summaryWe’ve written down VOXX’s receivables by 20% to $144.2M or $6.30 per share and VOXX’s investory by 50% to $74.7M or $3.26 per share to arrive at a total current asset value of $236.7M or $10.35 per share. Deducting total liabilities gives a net current asset value of $119.1M or $5.21. We’ve discounted $46M in non-current assets to $9.2M or $0.40 per share, which, added to the net current assets, gives a liquidation value of around $128.4M or $5.61 per share.

Off-balance sheet arrangements and Contractual obligations

According to its most recent 10Q, VOXX does not maintain any off-balance sheet arrangements, transactions, obligations or other relationships with unconsolidated entities that would be expected to have a material current or future effect upon its financial condition or results of operations.

VOXX has around $42M in contractual cash obligations (including $11M in capital lease obligations and $31M in operating leases), around half of which falls due in the next 5 years and $23.7M falling due after 5 years. VOXX also has another $43M in unconditional purchase obligations falling due in the next 12 months.

The catalyst

Howson Tattersall Investment Counsel Limited filed its 13D notice on September 24, 2008 disclosing a 7.3% holding in VOXX. It seems from the filing that Howson Tattersall paid $18,825,883.44 for 1,508,075 shares in VOXX, giving them an  average purchase price around $12.50 per share. Given that Howson Tattersall has listed in the filing the “Date of Event Which Requires Filing of this Statement” as April 11, 2007, it’s possible that they are an example of the “reluctant activists” we referred to on Monday.

Conclusion

At $3.73, VOXX is trading at a discount to its net current asset value and around two-thirds of our estimate of its liquidation value of around $5.61 per share. We’ve got no particular insight into the business. The negative operating cash flow is an issue and its near term contractual obligations are significant. That aside, we think VOXX is a reasonable punt and we’re adding it to the Greenbackd Portfolio.

VOXX closed yesterday at $3.73.

The S&P500 Index closed yesterday at 789.17.

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

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