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Archive for the ‘Ikanos Communications Inc (NASDAQ:IKAN)’ Category

Ikanos Communications Inc (NASDAQ:IKAN) has acquired the assets of the Broadband Access product line from Conexant Systems, Inc. (NASDAQ: CNXT) for $54M partially funded by a sale of $42M in common stock at $1.75 per share to Tallwood Venture Capital. Upon completion of the transaction, Tallwood Venture Capital will own approximately 45% of IKAN, which means that the possibility of any catalytic event occurring is now remote. While IKAN is still trading at a discount to our calculation of its liquidation and net cash values, without a catalyst our investment thesis is gone, so we’re exiting the position.

We opened the IKAN position at $1.14 and it closed Friday at $1.37, which means we’re up 20.2% on an absolute basis. The S&P500 Index was at 836.57 when we opened the position and closed yesterday at 866.23, which means we’re up 16.6% on a relative basis.

Post mortem

We started following IKAN (see our post archive here) because it was trading at a discount to its net cash and had retained a financial adviser to “assist it in exploring and evaluating strategic alternatives to maximize shareholder value.” IKAN disclosed in its September 10Q that it had retained investment bankers to advise the board about IKAN’s strategic options:

We recently decided to retain Barclays Capital (formerly Lehman Brothers) to provide financial advice regarding potential strategic options for the Company. Such options include, without limitation, financing transactions, acquisitions, strategic partnerships, corporate restructuring and other activities. There can be no assurance that the evaluation of our options will result in the identification, announcement or consummation of any transaction. If the Board of Directors does decide to authorize a transaction, that decision could cause significant volatility in the price of the Company’s outstanding common stock. Moreover, any transactions we do sign may not be acceptable to our stockholders. In addition, our investigation of strategic options may result in added costs, potential loss of customers and key employees as well as management’s distraction from ordinary-course business operations.

We said at the time that there seemed to be some appetite for acquisitions in this industry giving the example of IKAN’s competitor Centillium Communications Inc (NASDAQ: CTLM), which was acquired in October last year. We were hoping that IKAN was to be the vendor, but it seems the “strategic option” favored by IKAN and its investment bankers is to be the acquisition of Conexant’s Broadband Access product line. Here’s the press release:

Ikanos Communications Announces Plans to Acquire Conexant’s Broadband Access Product Line

Tallwood Venture Capital Invests $42 Million

Webcast and Conference Call Details Included for this Event and for

First Quarter 2009 Financial Results

FREMONT, Calif., April 22, 2009, Ikanos Communications, Inc. (NASDAQ: IKAN), a leading provider of broadband semiconductor and software products for the digital home, today announced the signing of a definitive agreement to purchase the Broadband Access product line from Conexant Systems, Inc. (NASDAQ: CNXT). The combined organization will have the expertise and resources required to satisfy the demand for powerful broadband network products around the world.

Under the terms of the agreement, which was unanimously approved by the boards of directors of both companies, Ikanos will purchase Conexant’s Broadband Access product line for $54 million in cash and the assumption of certain employee and facility related liabilities. In connection with this transaction, Tallwood Venture Capital, a leading investment firm focused on the semiconductor industry, has agreed to purchase 24 million shares of Ikanos common stock for $42 million, or $1.75 per share. Tallwood will also receive warrants to purchase an additional 7.8 million shares of common stock at $1.75 per share. The warrants will have a term of five years. Upon completion of the transactions, Tallwood Venture Capital will own approximately 45 percent of the outstanding shares of Ikanos (excluding the warrants). In addition, following the transaction, George Pavlov, general partner, and Dado Banatao, managing partner, will join Ikanos’ Board of Directors.

Ikanos’ purchase of Conexant’s Broadband Access product line is subject to customary closing conditions, including stockholder and regulatory approvals, and is expected to be completed in the third quarter of calendar year 2009.

Ikanos expects that the transaction will more than double the Company’s revenue, while providing significant leverage in its cost and spending structure. Ikanos also expects that the transaction will be accretive to its non-GAAP earnings per share within the first year after the close of the transaction.

“With the number of home networks doubling to more than 400 million by 2013 according to analysts, there’s a substantial opportunity for Ikanos to address the need for delivering bandwidth to and throughout the home,” said Michael Gulett, president and CEO of Ikanos. “We’ll use our strengthened leadership in broadband access as a platform on which to build new offerings that extend multi-play services seamlessly everywhere they are needed.”

Today, Ikanos and Conexant account for a cumulative 330 million broadband access ports shipped, bringing the power of the Internet to millions of people around the world. Conexant’s Broadband Access product line has traditionally been strong in North America and China while Ikanos has led in Japan, Korea and Europe. The combined company will be well positioned to address the global market for broadband semiconductors, and better serve customers in all geographies.

“Customers should not be concerned about product transitions. Once the acquisition is complete, the combined company will continue to make available and support the products acquired from Conexant along with the products of Ikanos,” added Gulett.

The combination of Ikanos and Conexant’s Broadband Access product line brings together the industry’s most comprehensive portfolio of broadband access products. Ikanos will build on its status as the VDSL market share leader, will add substantial ADSL market share, and will have a broad product portfolio that includes SHDSL, 802.11 b/g wireless networking, Ethernet switching, and passive optical networking (PON). In addition, the combined company will have both MIPS- and ARM-based processors that are powering broadband access networks around the world.

The combined company will also have the expertise to enable service providers and network equipment manufacturers to effectively build advanced networks, and deploy multi-play services including high-speed Internet, Internet protocol television (IPTV), voice-over Internet protocol (VoIP) and fixed-mobile convergence (FMC) offerings. The combined organization’s customers will include a vast array of industry leading network equipment manufacturers and service providers from around the world.

“The combined company brings together a talented team of employees that pioneered and set the standards for the broadband market,” said Craig Garen, senior vice president and general manager of Conexant’s Broadband Access business. “Going forward, we’ll continue to innovate and create new broadband access and home networking products that deliver enhanced value to the marketplace.”

Both Ikanos and Conexant have been strong, active proponents of industry standards, and are advancing the development of next-generation technologies like ITU-T G.hn for whole-home networking, retransmission and the dynamic spectrum management. The combined company will have a portfolio of intellectual property that will include well over 400 patents and applications.

“This transaction brings together a powerful combination of leading products, strong customer relationships, and deep technical expertise, all dedicated to the broadband market,” said George Pavlov, general partner at Tallwood Venture Capital. “The new company that emerges will be able to compete more effectively in existing and emerging markets, develop exciting new products, and provide greater value for its most important stakeholders – its customers, investors and employees.”

IKAN is still trading at a discount to both its net cash and liquidation valuations, so it’s difficult to exit when the possibility of additional upside is good. IKAN is still burning cash, so that value will deteriorate, and our investment thesis was based on some catalytic event occurring before the value was dissipated. Tallwood Venture Capital’s 45% holding (excluding the 7.8M warrants) means that Tallwood has control, which in turn means the chance of a catalytic event occurring that could realize that value is now low. For those reasons, we’re out.

Hat tip to JM.

[Full Disclosure:  We have a holding in IKAN. 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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Ikanos Communications Inc (NASDAQ:IKAN) is a net cash stock that has retained a financial advisor to “assist it in exploring and evaluating strategic alternatives to maximize shareholder value.” IKAN closed yesterday at $1.14, giving it a market capitalization of $32.9M. Based on its September 10Q, we estimate the company’s liquidating value to be more than 90% higher at $63.2M or $2.19 per share. IKAN’s liquidating value is predominantly cash, and it has a net cash value of $41.2M or $1.43 per share. With a deeply undervalued stock and a board and management taking proactive steps to realise the value, we think IKAN presents a good investment opportunity.

About IKAN

IKAN is a developer and provider of semiconductors and silicon and software solutions for “interactive triple-play broadband.” Its customers consist primarily of original design manufacturers (ODM), contract manufacturers and original equipment manufacturers (OEMs), such as NEC Corporation, Sagem Communications, Uniquest Corporation and Altima. Its customers include Alcatel-Lucent, Dasan Networks, Inc., Innomedia, Inc. and Millinet Co., Ltd. The company’s investor relations website can be found here.

The value proposition

As its September 10Q demonstrates, IKAN’s income statement is a horror show. The company has consistently generated losses for the last five quarters. IKAN’s balance sheet has some value (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):

ikan-summary

$66.2M of IKAN’s $85.8M current asset value is in cash. After deducting total liabilities of $25M, we estimate IKAN’s net current asset value at $60.8M, and its liquidating value at $63.2M or $2.19 per share. IKAN’s net cash value is $41.2M or $1.43 per share.

Contractual commitments and Off-balance sheet arrangements

According to the September 10Q, IKAN does not use off balance sheet arrangements with unconsolidated entities or related parties, nor does it use other forms of off balance sheet arrangements such as special purpose entities and research and development arrangements. Its liquidity and capital resources are not subject to off balance sheet risks from unconsolidated entities. IKAN leases office facilities, equipment and software under “non-cancelable” operating leases. Its contractual obligations as of September 28, 2008 are around $4.7M in total. In the normal course of business, IKAN provides indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products. Historically, costs related to these indemnification provisions have not been significant, but IKAN is unable to estimate the maximum potential impact of these indemnification provisions on its future consolidated results of operations.

The catalyst

The company disclosed in its September 10Q that it has retained investment bankers to advise the board about IKAN’s strategic options:

We recently decided to retain Barclays Capital (formerly Lehman Brothers) to provide financial advice regarding potential strategic options for the Company. Such options include, without limitation, financing transactions, acquisitions, strategic partnerships, corporate restructuring and other activities. There can be no assurance that the evaluation of our options will result in the identification, announcement or consummation of any transaction. If the Board of Directors does decide to authorize a transaction, that decision could cause significant volatility in the price of the Company’s outstanding common stock. Moreover, any transactions we do sign may not be acceptable to our stockholders. In addition, our investigation of strategic options may result in added costs, potential loss of customers and key employees as well as management’s distraction from ordinary-course business operations.

There seems to be some appetite for acquisitions in this industry. IKAN competitor Centillium Communications Inc (NASDAQ: CTLM) was acquired in October last year.

Conclusion

At $1.14, IKAN is trading at a little over half its liquidating value of $2.19 per share. With the board proactively seeking a new strategic direction, which might include “financing transactions, acquisitions, strategic partnerships, corporate restructuring and other activities,” we think there’s a good chance that IKAN can realise at least its liquidating value. We’re adding IKAN to the Greenbackd Portfolio.

IKAN closed yesterday at $1.14.

The S&P500 Index closed yesterday at 836.57.

Hat tip to Steven Lobo.

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