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Update: Biotechnology Value Fund sends a letter to AVGN

December 16, 2008 by Tobias Carlisle

We posted about Avigen, Inc. (NASDAQ:AVGN) on December 1, 2008, noting that it was a rare opportunity because it was a net cash stock (i.e. it was trading at less than the value of its cash after deducting all liabilities). Since our initial post, AVGN has fallen from $0.65 to close yesterday at $0.54. At $0.54, AVGN has a market capitalization of $16.1M against a net cash position of $36.5M, some 127% higher.

Biotechnology Value Fund (BVF), who we noted in our earlier post had an active interest in AVGN, filed an updated 13D last week. In the new filing BVF says that it sent a letter to AVGN “expressing its displeasure with [AVGN]’s recent performance and continued destruction of shareholder value.” The letter is reproduced below:

Members of the Board:

As you know, Biotechnology Value Fund, L.P., together with its affiliates, is the largest shareholder of Avigen, Inc. (“Avigen” or the “Company”), holding an ownership stake of approximately 29% of Avigen’s outstanding common stock. We first became investors in Avigen in 2004 and have provided capital directly to the Company. We are writing to express our frustration with recent developments at Avigen, particularly with what we perceive to be this Board’s self-serving actions and disregard of shareholder interests.

Since January 1, 2004, Avigen’s stock price has fallen more than 90% and the Company has accumulated a deficit of more than $110 million. Presently, Avigen’s stock trades at less than 1/3 of its net per share cash value, indicative of the investment community’s conviction that Avigen’s Board will destroy its remaining value. We have repeatedly reached out to the Company and have offered to work collaboratively to maximize shareholder value. The Company responded to our offers by unilaterally increasing and broadening management’s “golden parachute” severance agreements and by unilaterally adopting a “poison pill.”

The Board’s increase and broadening of its “golden parachute” severance agreements with management, under the ridiculous justification that such payouts are necessary to “attract and retain key employees,” is particularly outrageous given Avigen’s current circumstances. Our analysis indicates that these payouts, which we believe would be triggered by most “change in control” scenarios, including a liquidation, total at least $3 million, an incredible 20% of the Company’s entire market value. The recipients of these golden parachute arrangements include Avigen’s CEO, Ken Chahine, who resides in Park City, Utah, while the Company is based in California. How can the Company justify such actions as necessary to “attract and retain key employees” when Avigen has no real business at this time and has abandoned the development of all its products? These hastily adopted severance arrangements need to be revoked.

In addition, we believe the Board’s implementation of the “poison pill” serves no purpose other than to keep BVF from purchasing additional stock in the Company. We are concerned that management and Board members are more concerned with retaining their jobs and compensation than with maximizing shareholder value. As evidence, Avigen’s stock price has fallen more than 20% since the adoption of the poison pill. We find the poison pill to be disrespectful and offensive, given our substantial ownership position and our long history with the Company. Nevertheless, our response was to offer a compromise proposal: modify the poison pill to allow anyone to acquire as much stock as they like, however, neutralize the voting power on all shares of Avigen stock above a specified threshold. We specifically offered to have any additional shares that we acquire to abstain from voting or to vote in proportion to all other outstanding shares. This offer was not accepted. The pill should be redeemed altogether.

The Board’s recent actions reveal its true self-interest and leave us concerned that Avigen will indeed destroy and/or take all remaining value. Consequently, our primary issue has been and remains that Avigen immediately guarantee the worst case outcome for all shareholders. This guarantee could be accomplished in several ways, including by dividending or otherwise distributing all excess cash to shareholders now, or by offering to buy back any and all shares from holders that wish to sell at a specific price at a specific future date (i.e., $1.25 per share in December, 2009). In both cases, shareholders could stand to reap potentially substantial upside derived from the monetization of Avigen’s remaining assets and could finally stop worrying about whether the Company will destroy its substantial cash value. To the extent the Board believes it can generate value in excess of its cash in the bank today, offering downside protection ultimately costs the Company nothing. However, by rejecting our proposal to provide a downside guarantee, the Board has indicated its willingness to place its remaining cash at continued risk, without shareholder consent.

As the Company’s largest shareholder, we are fighting to return value to all shareholders, not just ourselves, and we feel a responsibility to do so. To be clear, we do not seek to impose our own agenda on Avigen, we only ask that shareholders be empowered to decide the fate of the Company’s residual cash, rather than the management and Board of a company which has repeatedly tried and failed to create any shareholder value whatsoever. Shareholders have good reason to worry that Avigen’s management fully intends to put its remaining cash at risk. Yesterday, at the RBC Capital Markets Healthcare Conference, CEO Ken Chahine said, “We are going to be looking at building…How do we do that?…There are some opportunities as well that have emerged from the credit crisis. There are some commercialization, or near-commercialization, type companies that could use an infusion of cash…Those are some of the things we are looking at. Now, will that be in the therapeutic space? It could be…We’re opening it up because I think that there are opportunities outside of therapeutics…We will spend the balance of 2009 trying to look for opportunities.” Mr. Chahine, shareholders do not need or want you to invest their money.

If recent empirical evidence with respect to numerous other failed biotech companies is any guide (e.g., Corgentech, Renovis, Novacea, Nitromed, Nuvelo and others), the future does not bode well for Avigen shareholders if left to its own devices. In one similar situation, the company could have returned in excess of $10/share in cash to shareholders had it been liquidated in 2005. Instead, after opting for a value-destroying merger, that company today trades at a mere 0.09 cents per share – a 99% decline! Avigen’s golden parachutes have incentivized management to merge with any company that will take it. Management would walk away with its $3 million cash windfall; shareholders would get stuck with potentially worthless stock in a merged company. In the current fiscal environment, shareholders will no longer tolerate such self-interested behavior on the part of failed biotechnology companies.

We believe the Avigen Board is not only willing to sacrifice and squander shareholder money but, in the process, its members are making a mockery of their obligations to fulfill their fiduciary duties as directors of the Company. To that end, please be advised that we intend to hold each member of the Board and management fully accountable for any continued erosion of value from the current liquidation value of the Company.

Sincerely,

Mark Lampert

Conclusion

As we noted in our earlier post, while it’s frightening to see AVGN hemorrhaging cash, BVF is working to persuade it to salvage what remains of the company’s value. If BVF is able to cause the company to quickly distribute its remaining cash to stockholders, AVGN is an attractive investment opportunity. The risk is that BVF is unable to persuade the company to do so before AVGN dissipates its remaining cash.

AVGN closed yesterday at 0.54.

The S&P 500 Index closed yesterday at 868.57.

[Disclosure: We do not presently have a holding in AVGN. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, Avigen (NASDAQ:AVGN), Biotechnology Value Fund, Net Cash Stocks, Stocks | Tagged , , | 7 Comments »

Electro Scientific Industries Inc (NASDAQ:ESIO)

December 16, 2008 by Tobias Carlisle

Electro Scientific Industries Inc (NASDAQ:ESIO) is one of the more complex undervalued asset plays we’ve dug up, but a worthwhile one to watch nonetheless. ESIO has announced a merger with Zygo Corporation (NASDAQ:ZIGO) and an authorization to buy back $100M in stock (see the October 16 announcement here). Activist investor David Nierenberg of Nierenberg Investment Management owns 15% of ESIO, supports the merger and is pushing the company to buy back stock. Management expects the the merger to be completed in the first calendar quarter of 2009.

About ESIO

ESIO and its subsidiaries provide high-technology manufacturing systems to the global electronics market, including advanced laser-based systems that are used to microengineer semiconductor device features in high-volume production environments. Website is here.

About ZIGO

ZIGO designs, develops, and manufactures ultra-high precision measurement solutions to improve its customers’ manufacturing yields, and top-tier optical sub-systems and components for original equipment manufacturers (OEM) and end-user applications. Website is here.

The value proposition

1. ESIO

As it stands now, ESIO is an undervalued asset sitation, with a market capitalization of $177M at yesterday’s close of $6.56. We estimate ESIO’s stand alone liquidating value at around $277M or $10.12 per share, which is 54% higher than its close, as the following summary analysis demonstrates (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

esio-summary

2. ZIGO

ZIGO, ESIO’s partner in the merger, has a market capitalization of $110M at it’s $6.54 close yesterday. We estimate ZIGO’s stand alone liquidating value at $118M or $7.00 per share. At $6.54 ZIGO is trading only slightly lower (about 7%) than its $7.00 per share liquidating value, and so is close to value, as the following summary analysis demonstrates (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

zigo-summary

The catalysts

1. Details of the merger

ESIO is offering 1.0233 shares of ESIO for each share of ZIGO. In the merger, ESIO will issue to ZIGO stockholders 18.1m shares of ESIO. This will increase the issued stock of ESIO from 27M pre merger to 45.1M post merger and give ZIGO stockholders 40% of ESIO. On October 15, the day before the announcement, ESIO closed at $10.07, valuing the merger $10.30 for each share of ZIGO, which had closed at $7.57.

The merger will reduce the liquidating value of each share of ESIO because ZIGO at $6.54 is trading much closer to its liquidating value than ESIO at $6.56. The following summary analysis shows ESIO after the merger with ZIGO is complete (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

esio-zigo-summary

After the merger we estimate that ESIO stock will have a liquidating value of $391M. This equates to $8.66 per share when the expanded number of ESIO stock on issue are taken into account, down from $10.12 per share pre-merger with ZIGO. A liquidating value of $8.66 per share is around 32% higher than ESIO’s close yesterday but it’s nothing to get excited about. Fortunately, the buy back goes some of the way to restoring ESIO’s liquidating value to pre-merger levels.

2. Effect of the buy back

In the announcement of the merger with ZIGO, ESIO also announced an authorization to buy back $100M of stock. If that $100M buy back was completed at $6.56, the closing price of ESIO yesterday, ESIO would buy back around 15.2M shares, leaving around 29.9M on issue. The following summary analysis assumes that ESIO buys back $100M of stock at $6.56 and shows ESIO after the buy back is complete (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

esio-zigo-summary-post-buy-back

The buy back increases ESIO’s per share liquidating value from $8.66 to $9.74. It’s legitimate to question whether all of this sturm und drang is worth it if it only serves to reduce the liquidating value of ESIO. The honest answer is that we don’t know but we suspect that it’s probably not. We think it would have made more sense for ESIO to buy back its own shares rather than merge with ZIGO. If a merger with ZIGO was an inevitability, perhaps it would have been better to buy back the shares before the merger, especially since ESIO seems to be getting less in value from ZIGO than the value it is issuing to ZIGO’s shareholders. There is also a risk that the buy back will not proceed. According to the announcement,

The repurchases will be made at management’s discretion in the open market in compliance with applicable securities laws and other legal requirements and are subject to market conditions, share price and other factors. There is no fixed completion date for the repurchase program.

3. David Nierenberg

According to his most recent 13D, David Nierenberg (The Motely Fool has a profile here) of Nierenberg Investment Management owns 15% of ESIO. The filing details Nierenberg’s agreement with ESIO regarding ESIO’s stockholder rights plan, which prevents any stockholder – other than 19.99% owner Third Avenue Management LLC – from owning more than 15% of the company. If any stockholder purchases more than 15%, the plan limits the stockholder to voting only that portion of the stockholding up equivalent to 15% of the outstanding stock. The other shares automatically vote with ESIO’s board. Nierenberg’s agreement with ESIO provides that if ESIO buys back enough stock to push Nierenberg’s holdings over 15% of the outstanding shares, he will still be able to vote all of his stock as he wishes. The agreement will be in effect for a minimum of three years.

Conclusion

ESIO as a stand alone entity is deeply undervalued, trading at less than two-thirds of its $10.12 per share liquidating value. The effect of the merger – which appears likely to succeed – is to reduce ESIO’s per share liquidating value to $8.66, which is only 35% higher than the company’s close yesterday. This will be remedied by the $100M buy back authorized for ESIO, which will increase ESIO’s per share liquidating value to $9.74, which is nearly 50% higher than yesterday’s close. There is a risk that the merger will go through but the buy back will not be completed but we think this risk is relatively low.

There are two ways to play this:

1. If you are confidant that the merger will go through, buying ZIGO at $6.54 is buying ESIO for $6.41 (a 2.3% discount). This is because in the merger each share of ZIGO equates to 1.0233 shares of ESIO ($6.56 / 1.0233).

2. If you believe there is a risk that the merger will not go through, ESIO offers the better downside protection because it is at a deeper discount to its liquidating value.

ESIO closed yesterday at $6.56.

ZIGO closed yesterday at $6.54, which equates to paying $6.41 for ESIO.

The S&P 500 closed yesterday at 868.57.

[Disclosure: We do not presently hold either ESIO or ZIGO.  This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, David Nierenberg, Electro Scientific Industries Inc (NASDAQ:ESIO), Nierenberg Investment Management, Stocks, Zygo Corporation (NASDAQ:ZIGO) | Tagged , , , , | 2 Comments »

InFocus Corporation (NASDAQ:INFS) Restructuring

December 15, 2008 by Tobias Carlisle

We’ve recently posted about INFS’s value proposition here (it’s deeply undervalued) and the effect of a big buy back on the per share value of the company here (it’s hugely positive).

The company today announced plans to restructure and reduce its global workforce by approximately 30%, commencing in January 2009 and spanning a twelve month period. The announcement also says that that INFS “believes it will achieve profitable operations with an 18% gross margin target and operating expenses in the range of $10-11 million per quarter.” While this may appear to be encouraging for stockholders, in our experience projections about future profitability often don’t turn out as projected. They are made by managements deaf to what the market is telling them about the company. As a result, we are much more interested in the company’s plans to unlock the value in the assets. On that front, the news is mixed.

INFS has previously announced that it had retained an investment banking firm to provide “advisory services.” The new announcement says that these advisory services include “advice concerning unsolicited offers from outside sources expressing interest in purchasing the Company.” This is a positive development. The bad news is that the company has suspended the stock repurchase plan, which is slightly disappointing. We say “slightly disappointing” because a buy back of 4 million shares over a three year period does not have a meaningful effect on the per share value, so cutting it makes almost no difference. It does show, however, that management is ignoring obvious value-enhancing opportunities for stockholders.

INFS will host a conference call to discuss the announcement tomorrow, December 16, 2008 at 9:00 a.m. (Eastern). No doubt Nery Capital Partners and Lloyd I. Miller, III will be on.

Hat tip to commenter Steven for the tip.

Posted in Activist Investors, InFocus Corporation (NASDAQ:INFS), Lloyd I. Miller III, Nery Capital Partners, Stocks | Tagged , , , , | Leave a Comment »

Kona Grill Inc (NASDAQ:KONA)

December 15, 2008 by Tobias Carlisle

Kona Grill Inc (NASDAQ:KONA) is an undervalued asset situation with a potential acquirer raising its stake in the company through November. Mill Road Capital made a cash offer in March to acquire KONA for $10.75 when the stock was trading at around $8.76. Since the offer was rebuffed by KONA in April the stock has slumped 85% to close yesterday at $1.31. Mill Road Capital has continued to buy stock, raising its stake to 10% in November from 8.2% in June. At $1.31, KONA has a market capitalization of just $7.9M. We estimate that its assets in liquidation are worth around $14.8M or $2.47 per share. With KONA trading at a discount of nearly 50% to its liquidating value and Mill Road Capital continuing to buy stock, we believe it is an attractive opportunity.

About KONA

KONA owns and operates 18 restaurants located in 12 states in the United States. The restaurants feature a selection of mainstream American dishes, as well as a range of appetizers and entrees with an international influence, including a selection of sushi. The menu items also incorporate over 40 signature sauces and dressings that Kona Grill makes from scratch, creating appeal for the lifestyle and taste trends of a diverse group of guests. The menu offerings are complemented by a full service bar offering an assortment of wines, specialty drinks and beers. Effective September 14, 2008, the Company closed its restaurant in Naples, Florida. KONA’s investor relations website is here.

The value proposition

According to the most recent 10Q, KONA has been consistently generating positive cash flow from operating activities. In the year ending December 31, 2007, the company generated $5.7M and has continued to generate positive operating cash flow each quarter for the last year. The company continues to consume cash, however, as it invests in new restaurants. While we believe that KONA has value as a going concern, our analysis demonstrates that the market is pricing its stock  at a substantial discount to its liquidating value (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

kona-summaryKONA’s value lies in its restaurants, carried on the balance sheet in its $53.7M in net property, plant and equipment. Discounting that figure by a third to $36M equates to $5.99 per share in value. Deducting all liabilities from the discounted assets leaves a liquidating value of around $14.8M or $2.47 per share.

The catalyst

Mill Road Capital is seeking to take KONA private. This 13D filing details Mill Road Capital’s investment thesis for KONA:

[Mill Road Capital] acquired shares of the Common Stock based on their belief that the Common Stock represents an attractive investment opportunity. [Mill Road Capital] further believe that [KONA] would be better able to realize its full value as a private entity.

On March 28, 2008, Mill Road Capital sent to Kona a non-binding offer to acquire all of KONA at a cash price of $10.75 per share:

Re: Notice of Acquisition Proposal

Ladies and Gentlemen:

Mill Road Capital, L.P. (“Mill Road”) is a substantial shareholder of Kona Grill, Inc. (“Kona” or the “Company”), currently owning approximately 325,000 shares or 4.9% of the Company. Mill Road has closely followed Kona since 2006, and we are extremely impressed with management and the Company. We believe that the public market does not adequately value small companies such as Kona, and by staying public, the Company will continue to be subject to undue regulatory burdens and pressure to maximize short-term results at the expense of long-term performance. We believe Kona will be better able to realize its full potential value as a private entity and are, therefore, making an offer to acquire all of the outstanding shares of the Company.

Mill Road is pleased to submit a non-binding offer to acquire all shares of the Company’s stock at a cash price of $10.75 per share. This represents a 23% premium to the closing price of $8.76 as of March 27, 2008. We would anticipate that the transaction would be accomplished through a merger of a company organized by Mill Road with and into the Company, as a result of which all stockholders of the Company would be entitled to this cash consideration.

Mill Road is a Greenwich, Connecticut based investment firm with approximately $250 million of committed equity capital. Our limited partners include a prominent and highly respected group of state pension funds, foundations, endowments and insurance companies. The investment professionals of Mill Road are a core group of former Blackstone professionals who have successfully completed more than 20 control transactions in which more than $600 million of equity capital was deployed with total transaction value of several billion dollars. Additionally, we have significant industry experience as a substantial investor in many public restaurant companies and through my position on the Board of Directors of Panera Bread Co. (NASDAQ: PNRA) from 2003 to 2006.

Our industry and transaction experience will allow us to quickly complete due diligence and definitive documentation. Considering the amount of our investable capital, Mill Road can readily fund the entire transaction contemplated by this acquisition proposal.

We are prepared to commence negotiations immediately with respect to this acquisition proposal and wish to close this transaction as soon as possible. We look forward to the opportunity to discuss our proposal in more detail with the Board of Directors and management. It would be our pleasure to meet in person at a location of your choice.

You may contact me directly at (203) 987-3501. I look forward to discussing our proposal at your earliest convenience.

Sincerely,
Mill Road Capital L.P.

By: Mill Road Capital GP LLC
Its General Partner

By:

Thomas Lynch
Senior Managing Director

KONA responded to Mill Road Capital on April 18, 2008 indicating that the letter had been distributed to KONA’s board for discussion at its next board meeting. On May 1, 2008, KONA told Mill Road Capital that it was not interested in pursuing the transaction.

Mill Road Capital has continued to purchase KONA stock, paying between $1.85 and $6.91 according to the latest amendment to their earlier 13D. As of November 14, 2008, Mill Road Capital controlled 10% of KONA.

Conclusion

KONA is an undervalued asset situation with a catalyst in the form of a potential takeover from Mill Road Capital. Given the deterioration in KONA’s stock price since the rejection of Mill Road Capital’s initial bid, we would not expect Mill Road Capital to offer $10.75 again. We do believe, however, that any bid would be at a premium to the current stock price. If we are wrong and a bid does not materialize from Mill Road Capital or some other acquirer, the down side should be limited because KONA is already trading at a substantial discount to its value in a liquidation.

KONA closed Friday at $1.31.

The S&P 500 closed Friday at 879.73.

[Disclosure: We do not presently hold KONA.  This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, Kona Grill Inc (NASDAQ:KONA), Mill Road Capital, Stocks | Tagged , , | 2 Comments »

Catalysts: Share buy-backs

December 15, 2008 by Tobias Carlisle

A stock buy-back is a great way for a deeply undervalued company to quickly increase its per share value. After identifying an undervalued asset situation, we look through the company’s filings to see if it has any existing plans authorizing it to buy-back its stock. On the rare occasions when we do locate such plans, we are often struck by (a) how few shares the company is authorized to buy back and (b) how few of the shares the company has actually bought back. InFocus Corporation (NASDAQ:INFS), which we posted about on Friday, is a classic example of this phenomenon.

INFS is trading at a big discount to its liquidation value, it has heaps of cash on hand and no debt, all of which makes it a prime candidate to undertake a big buy-back. Given the substantial discount to its current asset backing, any shares bought back at these levels have a huge positive effect on its per share value. It has just initiated a buy-back plan to repurchase over a three-year period up to 4M shares out of 40.7M on issue. As of September 30, the company had repurchased only 50,000 shares at an average price of $1.53 per share. 50,000 shares is simply too little to have any meaningful impact on the company’s value. We’d argue that even 4M (less than 10% of the outstanding common stock) isn’t enough. Why? Let’s look at what happens if the company repurchases many more shares, say 50% of its issued stock.

In our last blog post, we argued that INFS had a liquidation value of around $1.15 per share, 70% higher than its Friday close of $0.67. The company has cash and equivalents of around $55M and no debt as the summary financials demonstrate (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

Before

before-infs-summary

After

If INFS was to repurchase 50% of its stock (20M of its 40.7M shares currently on issue) at $0.67, it would cost INFS only $13.4M, leaving it with nearly $42M in cash on hand:

after-infs-summaryAfter the buy back, INFS’s per share liquidating value increases from $1.15 to $1.61 (a 40% increase).

There are very few investment opportunities that so quickly increase a company’s per share value. Given that management should know the company’s value better than the value of any other investment opportunity, it is also the most assured way of increasing a company’s per share value. There is simply no better way for an undervalued company to invest its excess cash than in its own stock.

Posted in About, Catalysts, InFocus Corporation (NASDAQ:INFS), Liquidation Value, Net Net Stocks, Stocks | Tagged , , , , , | 3 Comments »

InFocus Corporation (NASDAQ:INFS)

December 12, 2008 by Tobias Carlisle

InFocus Corporation (NASDAQ:INFS) is a deeply undervalued asset situation with two activist investors, Nery Capital Partners and Lloyd I. Miller, III, disclosing holdings in the company. At its closing price yesterday of $0.63, INFS has a market capitalization of $25.6M. We estimate its liquidating value to be more than 80% higher at $46.7M or $1.15 per share. With Nery Capital Partners and Miller pushing the company to enhance its stock price, we believe INFS is an attractive opportunity.

About INFS

INFS is a provider of digital projection technology. The company markets projectors and related accessories for use in the conference room, board room, auditorium, classroom and living room. “InFocus” is the company’s primary brand and is sold worldwide. In addition, many of the products are offered under a global reseller brand, “ASK Proxima.” INFS’s investor relation website is here.

The value proposition

According to its latest 10Q, INFS lost $25.6M last year and has continued to make losses in each of the last three quarters. The company does have some value on the balance sheet, as our summary analysis demonstrates (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

infs-summary

INFS has $124.7M in current assets, $55.2M ($1.36 per share) of which is cash and equivalents. We’ve discounted the receivables by a fifth to $31.4M or $0.77 per share and inventory by a third to $20.3M or $0.50 per share. The company has no debt but total liabilities of $81M or $1.99 per share. Deducting the liabilities leaves a liquidating value of $46.7M or $1.15 per share. INFS is currently trading at $0.63 or 55% of its value in liquidation.

The catalyst

Nery Capital Partners disclosed its original 9.8% holding in INFS in a November 5 13D filing. Initially purchasing its holding in INFS as a passive investment, Nery Capital Partners was moved to an active stance after an “evaluation of [INFS’s] financial performance and in light of [INFS’s] decreasing stock value.” Nery Capital Partners has since contacted the company’s board or management “with respect to, among other things, steps that [INFS] could take to improve [its] financial condition and increase shareholder value.” As of its amended filing dated December 5, Nery Capital Partners holds 11.2% of the company.

Lloyd I. Miller, III disclosed his 5% holding in INFS as a passive investment on November 5 in this 13G filing. On November 19, Miller updated his original filing to an active 13D filing. Miller said in the new filing that he acquired the holding in INFS as a passive investment but:

“…now believes it would be in his best interest, and those of other shareholders, to attempt to influence the governance and business strategies of the Company. Following Miller’s evaluation of the Company’s financial performance and in light of its recent declines in stock value, Miller decided that he may seek to contact the Company’s Board of Directors or management in order to engage in discussions regarding governance and enhancing shareholder value.”

Miller’s new filing states that he agrees with the views of Nery Capital Partners INFS is undervalued and represents an attractive investment opportunity and that the company should “consider the views expressed by its shareholders and pursue new alternatives to increase shareholder value.”

One alternative to increase shareholder value is to complete the stock back that the company initiated in the third quarter of 2008. Authorized to purchase up to 4M shares over a three-year period, as of September 30, the company had only repurchased 50,000 shares at an average price of $1.53 per share. Given the substantial discount of INFS to its current asset backing, any shares bought back at these levels have a large positive effect on the underlying asset value. We would like to see INFS buy back as many of the 4m shares as possible as rapidly as possible. Update (December 15): We’ve conducted an analysis of a buy back on INFS’s per share value. In short, if INFS buys back 20M of its 40.7M issued shares (approximately 50%) at Friday’s closing price of $0.67, it would increase its per share liquidating value from $1.15 to $1.61 (a 40% increase).

Conclusion

At $0.63 INFS is trading at 55% of its $1.15 per share value in liquidation. Although the stock jumped 25% yesterday, it is still very cheap. With Nery Capital Partners and Lloyd Miller in activist mode, this is an interesting opportunity.

Yesterday INFS closed at $0.63 and the S&P 500 Index closed at 873.59.

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

Posted in Activist Investors, InFocus Corporation (NASDAQ:INFS), Lloyd I. Miller III, Nery Capital Partners, Stocks | Tagged , , , , | 11 Comments »

Autobytel Inc (NASDAQ:ABTL)

December 11, 2008 by Tobias Carlisle

Autobytel Inc (NASDAQ:ABTL) is a net net stock with an investor declaring an active interest in late November. At yesterday’s close of $0.43, ABTL has a market capitalization of $19.4M and is trading at 55% of our estimate of its liquidation value of $35.3M. On November 21, 2008, Trilogy, Inc. filed its Schedule 13D notice, declaring an interest of 5.01%.

About ABTL

ABTL is a automotive media and marketing services company focused on helping dealers sell cars and services, and manufacturers build brands through marketing and advertising primarily through the Internet. The company owns and operates automotive websites MyRide.com, Autobytel.com, Autoweb.com, Car.com, CarSmart.com, AutoSite.com and CarTV.com. It connects automotive marketers with vehicle shoppers visiting these websites and third-party websites (primarily search engines, automotive information providers and other auto related venues). You can see the corporate website here.

The value proposition

ABTL’s most recent 10Q, specifically its earnings and cash flow, was abominable. The company lost $5.36M last year but surpassed that in the September quarter alone, losing$5.63M. ABTL had negative cash from operating activities last year of $6.91M and $2.88M in the quarter to September. As always we can find some value on the balance sheet, as our summary analysis demonstrates (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

abtl-summary1

With $32.2M or $0.71 per share in cash and equivalents on the balance sheet and total liabilities of $12.7M or $0.28 per share, ABTL is trading at its net cash value of $0.43. If we add in receivables of $12.7M (which we’ve written down by 20% to $10.2M or $0.22 per share), property, plant and equipment of $9.2M (written down to $4.6M or $0.10 per share) and a nominal $0.9M or $0.02 per share for the prepaid expenses, ABTL has a a liquidating value of $35.3M or $0.78 per share. ABTL’s liquidating value of $0.78 is 82% higher than its stock price of $0.43, which is a substantial margin for error (or safety).

The catalyst

Trilogy, Inc. filed its Schedule 13D notice, declaring an interest of 5.01% on November 21, 2008. The filing contains the standard boilerplate that says a great deal without actually disclosing Trilogy’s true purpose for the purchase.  Trilogy is a private operating company in the technology consulting industry, not a fund manager, so there is little public information available about its strategy. It seems odd for a technology consulting business to buy a substantial active stake in a listed company. It’s possible that the filing is a precursor to a bid for ABTL. An affiliate of Trilogy, Trilogy Automotive Advertising Services, operates a business focussed on the automotive industry. ABTL might fit nicely into that business. We’re only speculating, but on the basis that it might turn into a bid, ABTL is worth watching.

Conclusion

At its close yesterday of $0.43 ABTL is trading at its net cash and at a 45% discount to its value in liquidation. In short, it’s a bargain. With Trilogy disclosing an active interest that could be a precursor to a takeover bid, ABTL is worth a look.

ABTL closed yesterday at $0.43.

The S&P 500 Index closed at 899.24.

[Disclosure: We do not have a holding in ABTL. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Autobytel (NASDAQ:ABTL), Net Cash Stocks, Net Net Stocks, Trilogy | Tagged , , , | 4 Comments »

ValueVision Media Inc. (NASDAQ:VVTV)

December 10, 2008 by Tobias Carlisle

ValueVision Media Inc. (NASDAQ:VVTV) is exactly the kind of opportunity we like to find: a net net stock with a management taking active steps to rectify the situation. At yesterday’s close of $0.44, VVTV has a market capitalization of $14.8M, which is half its net current asset value of around $29.5M, or $0.88 per share and 20% of our estimate of its value in liquidation of around $74.8M or $2.23 per share. After receiving some full and frank advice criticism on an August earnings call, VVTV’s board of directors has publicly announced that it has appointed a special committee of independent directors to “review strategic alternatives to maximize stockholder value.” The company is currently conducting an auction expected to close in February 2009. The auction has uncovered a number of interested bidders, including GE Capital Equity Investments (most recent 13D filing here), which owns 13.7% of the company. Activist investor Carlo Cannell of Cannell Capital LLC has disclosed an interest in the company and has also sent a number of entertaining letters to the CEO (which we’ve reproduced below).

About VVTV

According to its website, VVTV is a direct marketing company that markets, sells and distributes products directly to consumers through various forms of electronic media and direct-to-consumer mailings. The company’s principal electronic media activity is the television home shopping business, which uses on-air spokespersons to market brand name merchandise and private label consumer products at competitive prices. A live around the clock television home shopping programming is distributed primarily through cable and satellite affiliation agreements and the purchase of month-to-month full- and part-time lease agreements of cable and broadcast television time. In addition, ValueVision Media distributes its programming through a television station in Boston, Massachusetts. It also markets and sells an array of merchandise through http://www.shopnbc.com and http://www.shopnbc.tv.

The value proposition

According to its most recent 10Q, VVTV lost $15.7M in the August quarter, which continues a string of five quarterly losses. Operating cash flow has also turned negative for the August quarter, which is particularly concerning. The company does have value on the balance sheet, however, as our summary analysis demonstrates (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

vvtv-summary1

With $59.7M in cash and equivalents, $55.7M in receivables and $55.6M in inventory, VVTV’s is trading at a substantial discount to its current assets alone. The company has $1.78 per share in cash. We’ve discounted the receivables by 20% to $44.6M or $1.33 per share and the inventory by a third to $37.3M or  $1.11 per share. Subtracting all liabilities of $74M or $2.20  per share and the preferred stock of $44.1M or $1.31 per share gives us a net current asset value for VVTV of around $29.5M or $0.88 per share. At yesterday’s closing price of $0.44, VVTV is trading at a 50% discount to its net current asset value alone.

VVTV has other valuable assets, including substantial property, its FCC broadcasting licence, its NBC trademark licence agreement and its Cable distribution and marketing agreement. We have no idea how to value these assets, but discounted by an arbitrary 50%, they are worth an additional $45.3M or $1.35 per share. This puts our estimate of the company’s liquidating value at around $74.8M or $2.23 per share, which means that VVTV is trading at 20% of its value in liquidation.

Carlo Cannell suggested in the October 27 letter to the CEO (reproduced below) that VVTV’s value is much higher. He thinks the company is “worth closer to $6.00 per share, exclusive of the $120 million net operating loss and substantial intangible value in the broad 72 million reach enjoyed by ShopNBC.” Cannell’s analysis is as follows (all figures are $/share figures):

Net Working Capital – $3.73 (Includes $2.39/share in Cash. Excludes NOL and value of Shop NBC.)
Headquarters – $1.03
Television Station – $0.95
NBC License Agreement – $0.27
Total Asset Value – $5.98

VVTV is trading at less than 7% of Cannell’s valuation.

The catalyst

VVTV’s stock is down about 91% ($5.53 per share) this year. During VVTV’s second-quarter conference call in August, shareholders lambasted management and called for the sale of the company. As a result, VVTV disclosed in its 10Q that it was pursuing “strategic alternatives”:

On September 11, 2008, our board of directors announced that it had appointed a special committee of independent directors to review strategic alternatives to maximize stockholder value. The committee currently consists of two directors: George Vandeman, who will serve as the committee’s chairman, and Robert Korkowski. We expect to appoint an additional independent director to the board, who we anticipate will serve on the special committee. The special committee retained Piper Jaffray & Co., a nationally-recognized investment banking firm, as its financial advisor. There can be no assurance that the review process will result in the announcement or consummation of a sale of our company or any other strategic alternative. We do not intend to comment publicly with respect to any potential strategic alternatives we may consider pursuing unless or until a specific alternative is approved by our board of directors.

On September 24, 2008 Cannell Capital amended an earlier 13G filing for VVTV in this 13D filing, annexing an entertaining letter from Carlo Cannell to Mr. John Buck, VVTV’s CEO (reproduced below):

Dear Mr. Buck

Cannell Capital LLC (“Cannell”), an investment adviser and General Partner to several private investment funds and partnerships, which own shares in ValueVision Media Inc. (“VVTV”), is amending its reporting requirements to reflect a more active stance.

Congratulations on your September 11, 2008 decision to appoint “a special committee of independent directors to review strategic alternatives to maximize shareholder value.” Cannell interprets this to mean that the representatives of the shareholders (aka “Directors”) have finally elected to monetize the assets on behalf of its owners.

ValueVision’s stock price is $2.20 per share. Based upon analysis our from Craig-Hallum it is our opinion the company is worth closer to $6.00 per share, exclusive of the $120 million net operating loss and substantial intangible value in the broad 72 million reach enjoyed by ShopNBC.(1)

                                                    $/Share
                                                    -------

                 Net Working Capital*                $3.73
                 Headquarters                        $1.03
                 Television Station                  $0.95
                 NBC License Agreement               $0.27
                 Total Asset Value                   $5.98

                 *Includes $2.39/share in Cash. Excludes NOL
                 and value of Shop NBC.

We will be watching carefully to make sure the committee’s actions are congruent with the interests of shareholders. We are concerned that the hiring of Piper Jaffray & Co. may be a ploy to continue to justify its pattern of wheel spinning and protection of jobs over what is best for the owners of the business. For example, on Monday, September 15, 2008 we were shocked to learn that your agent (Piper Jaffray & Co.) called to “permission” when and to whom we might talk at our Company. This is characteristic of Stalinist Russia, not America. This does not have a good taint to it. You may try to muzzle other investors, but not Cannell. It bites.

You further have called for representatives to the Board of Directors. We have several candidates in mind. Two will be contacting you shortly to present their credentials directly.

It is amazing to us how much value has been destroyed under your stewardship. That you would have to hire an agent at all to advise you on what should have been done long ago is shameful.

Godspeed!

J. Carlo Cannell
Managing Member
Cannell Capital LLC

————————-
(1) Robert J. Evans, Craig-Hallum Capital Group, 8/25/08

Cannell sent a follow up letter on October 27, 2008, which was annexed to this 13D filing and is reproduced below:

Dear Mr. Buck

Thank you for taking the time to speak with us this month. I imagine that you are busy consulting with sundry advisors as to ways to maximize shareholder value, including, but not limited to the immediate liquidation of our assets.

Regrettably, at this rate there will not be much value to realize. The price of the common stock has declined 65% this month alone.

I am sorry that you feel the name of the broker hired to sell our buildings at 6740, 6680 and 6690 Shady Oak Road, Eden Prairie, MN 55334 to be material non-public information. I disagree.

Given the slope of shareholder wealth destruction and given the inconsistency of information delivered to us by sundry directors and officers of our Company I would like to suggest that you deliver a special dividend of $1.20 per share to its owners, the shareholders.(1) Although I can’t speak for all shareholders, it is my opinion that most would see copious opportunities to allocate their capital to other stewards of this capital than that of the current board of VVTV.

If the board agrees with me, please tell me by Halloween when my investors and other shareholders might get their dividend. (Time is of the essence. If Senator Barack Obama is elected President the taxation of dividends is likely to become less favorable.) If you disagree, please state the reasons behind your opposition.

In the case of the latter outcome, Cannell Capital LLC will review your opposition and, if appropriate, we will evaluate our options in calling a special meeting of all shareholders to vote upon whether: (i) our cash should be returned to its owners or (ii) the existing board should be allowed to continue to manage it.

Best regards!

Sincerely

J. Carlo Cannell
Managing Member

————————-
(1) As of August 2, 2008, VVTV had $79.4 million of cash – $48.8 million of liquid, $10.9 million of short term equivalent and $20.5 million of auction rate securities (which should likely be discounted by $1.5 million). That is $2.36 per share. I like the idea that returning this cash is tax efficient and will deter management from performing more “science projects.” More pressure is good in my opinion.

On a conference call with analysts to discuss VVTV’s third quarter results, Mr. George Vandeman, who is chairman of VVTV’s special committee of independent directors, said the company had received bids from a number of companies and instructed its advisers to invite several of the proposed buyers to take part in the next phase of the process. Final bids would be due after that phase is completed. One of those interested bidders is GE Capital Equity Investments, which disclosed its holding in this November 17, 2008 13D filing. Vandeman also said the committee was “evaluating other alternatives to boost value, including share buybacks, paying a dividend and monetizing its balance sheet.”

The special committee and its financial advisors continue to review the full range of strategic alternatives available to the company. We anticipate that the special committee will conclude its review by the end of the fiscal year.

VVTV’s fiscal year ends February 2. These are all promising developments for VVTV.

Conclusion

This seems to us to be one of the better opportunities available in the present market. VVTV, a net net stock with additional valuable assets, is very cheap. At yesterday’s close of $0.44, VVTV has a market capitalization of $14.8M, which is half its net current asset value of around $29.5M, or $0.88 per share. Including the other assets – its property, FCC broadcasting licence, NBC trademark licence agreement and the Cable distribution and marketing agreement – we estimate VVTV is worth closer to $2.23 per share. Cannell Capital sees the value as high as $5.98 per share. The company also seems to be taking steps to realise that value, publicly announcing that it has appointed a special committee of independent directors to “review strategic alternatives to maximize stockholder value.” Currently, that means that the company is conducting an auction with a number of interested bidders but it may also mean the company buys back shares, pays a dividend or monetizes its balance sheet. The committee expect to complete this process by February 2, 2009, which means that this opportunity won’t be around for much longer.

VVTV closed yesterday at $0.44.

The S&P 500 Index closed at 888.67.

[Disclosure: We have a holding in VVTV. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, Cannell Capital, J. Carlo Cannell, Stocks, ValueVision Media (NASDAQ:VVTV) | Tagged , , , , | 7 Comments »

Chromcraft Revington (AMEX:CRC)

December 9, 2008 by Tobias Carlisle

Chromcraft Revington (AMEX:CRC) is a tiny, AMEX-listed net-net stock with a substantial stockholder calling for its sale or orderly liquidation. CRC has a market capitalization of only $2.8M, but the company’s written-down net current asset value is much higher at around $15M. The only problem? The company is in a liquidity crisis and risks entering bankruptcy if its fortunes don’t turn around. Aldebaran Capital, LLC, a 7.7% stockholder, sent a letter to the company on October 29 arguing that if CRC is unable to “promptly stabilize its business and rationalize its cost structure” it should be sold or liquidated.

About CRC

CRC is engaged in the design, production, sales and import of residential and commercial furniture. It markets its residential furniture products under the CR-Home banner with the brand names Chromcraft, Peters-Revington, Cochrane, Sumter and Silver. CRC distributes its products throughout the United States and Canada, primarily through furniture dealers. The history of the company is available on its website.

The value proposition

CRC is one of the most deeply undervalued asset situations we’ve uncovered, which is no surprise given the parlous state of its earnings and operating cash flow. The company made a loss of $14.87M last year and a loss of $3.39M in the 2006 financial year. Cash from Operating Activities has also been disappointing, negative to the tune of $3M in 2007 and $4M this quarter. All is not doom and gloom however: some residual value can still be found on the balance sheet.

Set out below is our summary analysis (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

crc-summary

A quick glance at the balance sheet shows that CRC is in a liquidity crisis. The company had $8.4M in cash 12 months ago, but has burned through it since then. In three quarters the receivables have reduced from $18.4M in March to $16.3M in this quarter, with none of it flowing through to cash. The company states in its 10Q that it has “several sources of cash” that it believes will be “adequate to meet its short term liquidity requirements.” These are as follows:

  • At September 27, 2008, [CRC] has unused borrowing capacity of approximately $14,231,000 under its Bank Facility.
  • [CRC] expects to receive asset sale proceeds of approximately $3,300,000 in 2009 from the sale of its Lincolnton, North Carolina buildings, machinery and equipment.
  • At September 27, 2008, [CRC] has refundable income taxes of $3,462,000, primarily from net operating loss (NOL) carrybacks, which are expected to be received in the fourth quarter of 2008.
  • [CRC] plans to sell excess inventories and generate cash of approximately $3,000,000 in 2009.
  • [CRC] has recently implemented spending controls and overhead expense reductions in personnel.
  • Future capital spending for information technology upgrades will be delayed to 2010.

CRC’s bankruptcy is not necessarily a problem for an investor if the assets are sufficient to pay out the liabilities and leave some residual value in excess of the current stock price. We think that there is a good chance that this is the case, provided that some action is taken soon to preserve the remaining value.

Assuming the board acts quickly to salvage what remains of CRC, we estimate the company’s per share value in liquidation at around $2.45 or $15M in toto. To reach this estimate, we’ve written down the receivables by a quarter to a little over $12M or $2.00 per share, inventory by two-thirds to $12M or $1.96 per share and Property, Plant and Equipment by 85% from $46M to $6.9M or $1.13 per share. Deducting Total Liabilities of $16.4M or $2.68 per share leaves a value in liquidation of around $2.45 per share.

The catalyst

Aldebran Capital acquired its 7.7% holding in CRC in September and October of this year, paying between $0.42 and $2.72 per share. In a letter to CRC’s chairman, Aldebran Capital has asked the board to take steps to preserve the remaining value. Aldebran Capital’s letter annexed to its 13D filing of October 29, 2008 is reproduced below:

Dear Mr. Chairman:

Aldebaran Capital, LLC is an Indiana limited liability company and registered investment advisor. As noted in our recent filing, we have acquired 7.7% of the outstanding shares of Chromcraft Revington, Inc.

We have followed the transformation of the company over the past few years, as Chromcraft has undergone a major change in its business model.

As security analysts, we recognize the challenges the company has faced in implementing its plan. In addition, we fully understand that current economic conditions are causing the task to be even more difficult.

However, the company is nearly three years into restructuring maneuvers that were begun in 2006. Along the way, Chromcraft has incurred significant losses and continues to accrue costs attendant with these changes. As shareholders, we believe that it is time for the company to demonstrate that these actions are bearing fruit.

In our opinion, if the company is unable to promptly stabilize its business and rationalize its cost structure, we believe that the Board should consider either: a) the sale of the company or, b) undertake an orderly liquidation of the company assets.

We look forward to speaking with you further about Chromcraft.

Sincerely,

Kenneth R. Skarbeck
Managing Member,
Aldebaran Capital, LLC

Conclusion

It’s always difficult to recommend a stock in a liquidity crisis, but crises are what create the wide disparities between value and price, or, in other words, the bargains. CRC is such a bargain. At its close yesterday of $0.46, CRC is trading at a tiny 20% of our estimate of its liquidation value of around $2.45 per share. While there is substantial value on the balance sheet relative to the stock price, the risk is that the company continues to trade and destroys that remaining value. This is always the risk with net net stocks. The good news is that Aldebaran Capital has already called for CRC’s board to take some stockholder friendly steps. We think that Aldebran Capital will be successful and CRC’s value will sooner or later be reflected in its stock.

Warning: When trading in tiny, thinly traded stocks with a wide bid-ask spread, make sure you set a limit on the stock order or you might end up paying more than you want.

CRC closed yesterday at $0.46.

The S&P 500 Index closed at 909.70.

[Disclosure: We do not have a holding in CRC. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, Aldebran Capital, Chromcraft Revington (AMEX:CRC), Net Cash Stocks, Net Net Stocks, Stocks | Tagged , , , , | 1 Comment »

Yahoo! Inc. (NASDAQ: YHOO)

December 8, 2008 by Tobias Carlisle

Today we continue our “Net Net vs Activist Legend” thought experiment, with Yahoo! Inc. (NASDAQ: YHOO).

YHOO is a stock that is not cheap on an asset basis but it does have a prominent activist investor with a 5.5% stake and two seats on the board. At its Friday close of $11.66, which is around two-thirds lower than Microsoft’s May 2008 $33 bid, YHOO still trades at a 70% premium to our $6.82 per share estimate of its asset value. Activist investor Carl Icahn’s presence on the register, however, indicates that he believes YHOO is worth more. Icahn has paid an average of $23.59 per share to accumulate his 5.5 percent stake. At $11.66, YHOO must more than double before Icahn will see a profit. He’s unlikely to sit idly by to see if that happens.

About YHOO

According to the Overview section of the company’s most recent 10Q*, YHOO “is a leading global Internet brand and one of the most trafficked Internet destinations worldwide.” Clear enough, but here is where the 10Q gets weird:

We are focused on powering our communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust.

We have no idea what “indispensable experiences built on trust” means. We’d be keen to hear your thoughts in the comments (but we digress):

We seek to provide Internet services that are essential and relevant to these communities of users, advertisers, publishers, and developers. Publishers, such as eBay Inc., WebMD, Cars.com, Forbes.com, and the Newspaper Consortium (our strategic partnership with a consortium of more than 20 leading United States (“U.S.”) newspaper publishing companies), are a subset of our distribution network of third-party entities (referred to as “Affiliates”) and are primarily Websites and search engines that attract users by providing content of interest, presented on Web pages that have space for advertisements. We manage and measure our business geographically. Our geographic segments are the U.S. and International.

According to Wikipedia, YHOO:

…provides Internet services worldwide. The company is perhaps best known for its web portal, search engine, Yahoo! Directory, Yahoo! Mail, news, and social media websites and services. Yahoo! was founded by Jerry Yang and David Filo in January 1994 and was incorporated on March 1, 1995.

According to Web traffic analysis companies (including Compete.com, comScore, Alexa Internet, Netcraft, and Nielsen Ratings), the domain yahoo.com attracted at least 1.575 billion visitors annually by 2008. The global network of Yahoo! websites receives 3.4 billion page views per day on average as of October 2007. It is the second most visited website in the U.S., and the most visited website in the world.

* We usually link to a company’s own description of its business on its website. We didn’t for YHOO because we couldn’t find on its website a concise description of the company or its business. While this may speak more to our own ineptitude, it might also be a telling sign for a “leading global Internet brand” that has struggled lately, no?

The value proposition

Before we launch into our analysis of YHOO, we have to state up front that Greenbackd’s focus is on undervalued asset situations, and preferably undervalued tangible assets. One would think that with YHOO, a “leading global Internet brand”, one would find a great deal of value in its intangible assets. Our bias for tangible over intangible assets will almost certainly lead us to a lower valuation for YHOO than another investor with a preference for intangible assets which generate earnings or cash flow.

Set out below is our summary analysis (the “Carrying” column shows the assets as they are carried in the financial statements, and the “Liquidating” column shows our estimate of the value of the assets in a liquidation):

yhoo-summary

Ordinarily, when we discount a company’s assets we get a much lower liquidating value than carrying value. In YHOO’s case, most of the tangible asset value is in the Cash and Short Term Investments which we don’t write down ($3.2B or $2.32 per share) and Long Term Investments (carried at $3.2B or $2.31 per share), which we’ve only written down to $3B or $2.19 per share for reasons we’ll explain below. We’ve written down the Property, Plant and Equipment by 85%, but it only represents a small proportion of the total tangible assets and so doesn’t have a meaningful impact on the valuation. Our usual liquidation valuation – the Armageddon scenario – for YHOO is $5.4B or $3.91 per share.

We believe that the Armageddon scenario substantially undervalues YHOO because it excludes the Goodwill in the Investments in Equity Interests (which is included in the Long Term Investments above). Including the Goodwill, YHOO’s Investments in Equity Interests amount to the following:

  • a 44% equity interest in Alibaba Group valued at $2.2B
  • a 1% equity interest in Alibaba.com Limited valued at $52M and
  • a 33% equity interest in Yahoo! Japan valued at $6B.

Including the Goodwill figures in the Investments in Equity Interests above (but deducting the Deferred Income Tax) gives us an asset valuation for YHOO closer to $9.5B or $6.82 per share.

Icahn said in an interview with CNBC last Wednesday that he believes YHOO is undervalued and that he “opposes breaking up the company in a piecemeal sale” (NY Times’ Dealbook has the transcript). While we can only speculate as to Icahn’s investment thesis for YHOO, that statement leads us to believe he is valuing it on an earnings or cash flow basis. YHOO’s Cash from Operating Activities is impressive at $1.9B in 2007 and $347M in the most recent quarter to September. Even more impressive is that it achieved that operating cash flow on only $9.5B of equity (up from $9.1B in the prior year), which means it returned around 21% on average equity. We’ve got no idea about the future economics of YHOO’s businesses or the industry as a whole, so we can’t predict whether YHOO can continue to generate these types of returns and we won’t be speculating as to its value on an earnings or cash flow basis.

The catalyst

Icahn, who currently sits on the board and holds 5.5% of the company, will be the driving force in any deal involving YHOO. His decisions will likely be informed by the fact that he has paid an average of $23.59 per share to accumulate a 5.5 percent stake (according to this filing with the SEC). There are a number of suitors seeking to consummate a marriage with YHOO. This Wall Street Journal article (subscription required) suggests former AOL chief Jonathan Miller is talking to investors about raising money to purchase all or part of YHOO. Icahn has said that he would be opposed to a partial bid “even at a premium.” He also expressed doubts about Miller’s ability to raise the money but would be willing to listen if Miller made a “bid at a very high price”. Another possibility is Microsoft, which has recently engaged a former YHOO search and advertising executive, but Microsoft CEO Steve Ballmer told the Wall Street Journal Thursday (subscription required) that there were no talks to acquire YHOO’s search business.

Icahn has a long history of succesful activist investment, with recent high profile campaigns against  Blockbuster, Imclone, XO Communications, Mylan Laboratories and Time Warner. According to this 2007 Fortune profile, he is renowned for taking on the biggest targets while generating exceptional returns:

In its less-than-three-year existence, Icahn Partners has posted annualized gains of 40%, investors told Fortune. After fees, the investors pocketed 28%. That 40% gain trounces the S&P 500’s return of around 13%, as well as the 12% for all hedge funds calculated by research firm HedgeFund.net. Icahn Partners boasts a string of big wins in short periods. The acquisition of energy producer Kerr-McGee gave the fund a $300 million gain, or a 100% return in just nine months. Icahn Partners achieved gains of $100 million and $230 million, respectively, both in less than three months, on forcing the sales of Fairmont Hotels & Resorts and drugmaker MedImmune.

The same Fortune article suggests that Icahn’s biggest strength is his knack for picking targets:

His skill at prospecting is so well honed that in most cases he’s destined to make money from the day he buys the shares. Then it’s a matter of squeezing management to sweeten the inevitable gains.

This is high praise indeed. Given that Icahn has paid an average of $23.59 per share for YHOO, he clearly sees value well in excess of that number and will be agitating for it to be realised.

Conclusion

YHOO is not cheap on any theory of value we care to employ. It is trading at a substantial premium to its asset backing, which means the market is still generously valuing its future earnings. It is generating substantial operating cash flow and earnings, which in a better market might be worth more, but it’s not obviously cheap to us.

The best thing about YHOO from our perspective is the presence of Carl Icahn on the register. His holdings were purchased at much higher prices than are presently available and he is unlikely to sit idly by while the stock stagnates.

Buying YHOO at these prices is a bet that Icahn can engineer a deal for the company. Given his legendary status as an activist investor earned through canny acquisitions over many years, we think that’s a good bet. But a bet is what it is – it’s speculation and not investment. If speculation is your game, then we wish you the best of luck but know that the price might fall a long way if he sells out. If you’re an investor, the price is too high.

YHOO closed Friday at $11.66 and the S&P 500 Index closed at 876.07.

[Disclosure: We do not have a holding in YHOO. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only.]

Posted in Activist Investors, Carl Icahn, Stocks, Yahoo! (NASDAQ:YHOO) | 2 Comments »

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