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Posts Tagged ‘Ditech Networks Inc (NASDAQ:DITC)’

The board of Ditech Networks Inc (NASDAQ:DITC) has agreed to nominate Lamassu Holdings’ representatives, Alan B. Howe and Frank J. Sansone, to be elected to the board at DITC’s next annual meeting. It seems that the board’s concern in nominating Howe and Sansone was that they not participate in any “withhold the vote” campaign or disparage the board. It’s a big win for Lamassu, and it appears their letter writing campaign was successful. The stock is now trading at a premium to our estimate of its liquidation value, which value is continuing to deteriorate, so we’re exiting the position. The stock is up from our initial $0.89 to close Friday at $1.75,which is an absolute return of 96.6%. The S&P500 closed at 788.42 when we opened the position, and closed Friday at 1,0472.73, which means our outperformance over the S$P500 was 64.4%.

Post Mortem

We started following DITC (see our archive here) because it was trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu had previously offered to acquire DITC for $1.25 per share in cash. At that time, Lamassu said that it “[anticipated] its due diligence requirement [would] take no more than two weeks and there [was] no financing contingency.” Lamassu then nominated two candidates for election to the board “who [were] committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” Lloyd I Miller III subsequently disclosed a 5.9% holding. Miller came out in support of the director candidates nominated by Lamassu as “candidates who [were] independent of management.” Miller said he sought “to encourage greater attention to corporate governance by all members of the Board of Directors.”

Lamassu then initiated a pointed letter campaign aimed at DITC’s board. In the first letter, Lamassu accused DITC management of “spending as though Ditech Networks has money to burn, adding to the amount of money you have already lost for shareholders during your tenure,” “aggressively [overstepping] the bounds of good corporate governance” and “clearly [violating] your fiduciary responsibility.” In the second, Lamassu claimed that the “decisions of this board [had] shown a pattern of director entrenchment characterized by prioritizing the interest of its members in the face of poor results at the expense of the shareholders” and called for shareholders to “receive ample representation on the board.” The campaign was succesful, and DITC agreeing to nominate Lamassu Holdings’ representatives for election to the board. The stock is up from our initial $0.89 to close Friday at $1.75, which gives the company a market capitalization of $46M. We last estimated the net cash value at around $32.2M or $1.23 per share and the liquidation value at around $43.4M or $1.65 per share. With the stock at a premium to the liquidation value, and that liquidation value deteriorating, we’ve decided to exit the position for a 96.6% gain.

The proxy statement for DITC’s 2009 annual meeting of stockholders more fully describes the agreement between Lamassu and DITC thus:

The Board of Directors currently has seven members. There are two directors in the class whose term of office expires in 2009. Both of the directors currently in serving in this term will not be standing for re-election. The Board of Directors has nominated two new persons to fill these positions. The two nominees, Mr. Alan B. Howe and Mr. Frank J. Sansone, are not currently directors of Ditech. The nomination of each of Mr. Howe and Mr. Sansone was recommended by a securityholder. If elected at the annual meeting, each of the nominees would serve until the 2012 annual meeting and until his successor is elected and has qualified, or until the director’s death, resignation or removal.

On September 2, 2009, Ditech and Lamassu Holdings L.L.C. and certain of its affiliates (collectively, “Lamassu”), entered into a letter agreement in which Ditech and Lamassu agreed that each of Mr. Howe and Mr. Sansone would be nominated to be elected to the Board of Directors at this annual meeting. In addition to the nomination of each of Mr. Howe and Mr. Sansone for election to the Board of Directors, the letter agreement also provides that:

• If Mr. Sansone is unable to serve as a director at a time when Lamassu owns at least 5% of the Ditech common stock, Ditech will appoint a replacement director designated by Lamassu and reasonably acceptable to Ditech Networks;

• Mr. Sansone and any replacement director will sign a conditional resignation from the Board of Directors, which may be accepted by the Board of Directors in the event that Lamassu’s beneficial ownership of Ditech common stock falls below 5% of the outstanding Ditech common stock;

• Lamassu will vote all of the shares it beneficially owns in support of the slate of directors nominated by the Board of Directors at this annual meeting of stockholders (and will not support or participate in any “withhold the vote” or similar campaign, or support any other nominees other than the slate of directors nominated by the Board of Directors);

• Lamassu withdrew its previously announced notice of its intent to nominate directors with respect to this annual meeting of stockholders;

• For a period ending 90 days from the date of this annual meeting of stockholders, Lamassu will not (i) make any public statement regarding Ditech, the Board of Directors or any of Ditech’s officers, directors or employees, except for the press release attached to the agreement or as may be required by law, or (ii) disparage Ditech, the Board of Directors, or any of Ditech’s officers, directors or employees, in any manner, including in any manner which could be harmful to Ditech or its business, the Board of Directors or its reputation, or the business reputation or personal reputation of any officer, director or employee of Ditech.

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

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Lamassu Holdings has sent another scorching letter to the board of Ditech Networks Inc (NASDAQ:DITC). In the letter, Lamassu claims that the “decisions of this board have shown a pattern of director entrenchment characterized by prioritizing the interest of its members in the face of poor results at the expense of the shareholders” and has called for shareholders to “receive ample representation on the board.”

We’ve been following DITC (see our archive here) because it is trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has previously offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” Lamassu has now nominated two candidates for election to the board “who are committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” Lloyd I Miller III has also disclosed a 5.9% holding and has come out in support of Mr. Leehealey and Mr. Sansone – the director candidates nominated by Lamassu Holdings for election to the board of directors at the DITC annual meeting – as “candidates who are independent of management and he seeks to encourage greater attention to corporate governance by all members of the Board of Directors.” The stock is up 47.2% from our initial $0.89 to close yesterday at $1.31, giving the company a market capitalization of $34.5M. We last estimated the net cash value at around $32.2M or $1.23 per share and the liquidation value at around $43.4M or $1.65 per share. While the deterioration in value is a concern, Mr. Miller’s support of Lamassu Holding’s director candidates introduces a new element to the position. We’re inclined to hold on to see how the annual meeting plays out.

The press release setting out the text of the open letter from Lamassu Holdings is set out below:

Lamassu Holdings LLC Says Ditech Network’s Board of Directors Benefits at Shareholders’ Expense

Lamassu Holdings LLC files an open letter to the Board of Directors of DITECH NETWORKS, INC. (NASDAQ: DITC)

NEWPORT BEACH, Calif.–(BUSINESS WIRE)–Lamassu Holdings, LLC has sent the following letter to the Board of Directors of Ditech Networks, Inc.

Dear Board of Directors:

The purpose of this letter is to inform you that while you have historically operated with impunity in your role as Directors of Ditech Networks (NASDAQ: DITC – News), going forward your actions will be regarded with a much higher degree of scrutiny. The decisions of this board have shown a pattern of director entrenchment characterized by prioritizing the interest of its members in the face of poor results at the expense of the shareholders. In light of this trend, it is time that the shareholders receive ample representation on the board.

We have taken the time to go through the company’s filing and pull out some of the decisions that were clearly made to benefit the board while adding no value to shareholders. It is worth noting that these decisions were, for the most part, made by the same people who currently serve. We believe these decisions illustrate that, with the exception of Mr. Simpons and Mr. Dramis, all of the currently serving members, including Mr. Harper, Mr. Manoliu, Mr. Sugishita, Mr. Hasler and Mr. Avis, have established a clear pattern of rewarding themselves while shareholders suffer.

In 2003 (see Figure 1), Ditech Networks moved from a policy in which board members were paid in options to one in which they were paid with both cash and options. It is worth noting that during the three years prior to this change, there was a dramatic drop in the equity value of the company. In short, since the options you awarded yourselves were no longer worth anything, you chose to guarantee your compensation regardless of performance.

In 2005, after another very difficult period for shareholders, shown in Figure 2, the Board again rewarded itself with pay raises. Beginning on July 15, 2005, non-employee directors began receiving an annual retainer of $16,000; the chairman of the Audit Committee received an additional annual retainer of $5,000; and the chairmen of the Compensation Committee, the Corporate Governance Committee and the Nominating Committee received additional annual retainers of $2,500.

The final insult is the most recent decision made little more than a year ago. As the table below shows, effective May 1, 2008, the Board raised its salaries and several other fees. Ironically, you even actually raised the amount you get paid for “phoning it in” [“Special (telephonic)” line items below]. To put these pay increases in their full context, at the time you granted these raises for yourselves the stock was hitting all time lows on a daily basis and wouldn’t ultimately level off until it reached well below a dollar. In addition, the fundamentals of the company were never as bad as they had been. As a result of poor decisions and failed strategic maneuvers by the Board of Directors, the company had lost millions and millions of dollars. Despite this backdrop, you rewarded yourselves with additional cash at a time when the company apparently didn’t have enough money to buy back its own stock, despite the record low levels.

Lamassu Letter Table

(The table above has been modified from the original to fit this space)

Had compensation increases been used to attract new talent to the Board of Directors and resulted in new directors that brought with them a history of sound business decisions and responsible business practices, then the pay raises could be justified. However, the pay raises were not used for this purpose. Instead, in the face of massive shareholder equity losses and a long list of bad investments, the Board increased its pay with no regard for the massive losses the shareholders were experiencing—losses that were painless for the members of the Board due to their low levels of stock ownership. It is clear that under the current leadership, it has been more financially rewarding to be on the Board than to be a shareholder. For this reason and many others Lamassu has moved to replace two of the current board members with its own nominees. It is our hope that this will both give shareholders a direct voice on the Board, as well as bring about a level of fiduciary responsibility that we believe is currently lacking.

Sincerely,

Lamassu Holdings, LLC

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

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Lamassu Holdings has blasted the board of Ditech Networks Inc (NASDAQ:DITC). In a letter to the board, Lamassu Holdngs accuses DITC management of “spending as though Ditech Networks has money to burn, adding to the amount of money you have already lost for shareholders during your tenure,” “aggressively [overstepping] the bounds of good corporate governance” and “clearly [violating] your fiduciary responsibility.”

We’ve been following DITC (see our archive here) because it is trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has previously offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” Lamassu has now nominated two candidates for election to the board “who are committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” Lloyd I Miller III has also disclosed a 5.9% holding and has come out in support of Mr. Leehealey and Mr. Sansone – the director candidates nominated by Lamassu Holdings for election to the board of directors at the DITC annual meeting – as “candidates who are independent of management and he seeks to encourage greater attention to corporate governance by all members of the Board of Directors.” The stock is up 44.9% from our initial $0.89 to close yesterday at $1.29, giving the company a market capitalization of $33.9M. We last estimated the net cash value at around $32.2M or $1.23 per share and the liquidation value at around $43.4M or $1.65 per share. While the deterioration in value is a concern, Mr. Miller’s support of Lamassu Holding’s director candidates introduces a new element to the position. We’re inclined to hold on to see how the annual meeting plays out.

The press release setting out the text of the letter from Lamassu Holdings is set out below (via Yahoo Finance):

NEWPORT BEACH, Calif.–(BUSINESS WIRE)–Lamassu Holdings, LLC (“Lamassu”) has sent the following letter to the Board of Directors of Ditech Networks, Inc. (NASDAQ:DITC – News) (“Ditech Networks”) Members of the Board:

Over the past month a significant number of shareholders have either publicly, through filings, or privately rejected your leadership by expressing their support for Lamassu’s director nominees. Instead of listening to these shareholders and correcting your course, you push forward spending as though Ditech Networks has money to burn, adding to the amount of money you have already lost for shareholders during your tenure. Your recent decision to tie executive compensation to a level of investment associated with mStage/toktok, an unproven technology that to date has produced no revenues and has no immediate prospects, is outrageous and limits management’s ability to make the hard but intelligent decisions to reduce investment in that technology if its prospects for revenue continue to be elusive. With this measure we believe you have aggressively overstepped the bounds of good corporate governance and have clearly violated your fiduciary responsibility.

Investors in Ditech Networks (NASDAQ: DITC – News) are not venture capitalists and did not sign up for this type of speculative investing with such a large portion of the Company’s assets. Management needs to have the latitude to make the decisions that are appropriate given the revenue prospects of each product and the Board should ensure that no individual investment puts the Company in as much jeopardy of total failure as the mStage/toktok investment does.

In addition, given the level of support for Lamassu’s slate of director nominees, we remain completely perplexed by your apparent desire to engage in a pointless proxy fight and waste Company resources to protect your own interests. It is obvious shareholders will aggressively reject the idea of spending millions of dollars of their money in this manner when the addition of Lamassu’s nominees to the Board will clearly provide a much needed new perspective that is not steeped in the countless mistakes of the past or married to visions and dreams that produce little or nothing in the way of actual revenue.

For the sake of all investors we encourage you to radically alter your behavior and begin listening to shareholders as opposed to pursuing your own interests and extremely risky agendas. While you personally will not be significantly harmed if mStage/toktok is unsuccessful and Ditech Networks ultimately fails, many investors are not in a position to so casually lose their money.

Sincerely Lamassu Holdings, LLC

Hat tip to Toby.

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

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Lloyd I Miller III has disclosed a 5.9% holding in Ditech Networks Inc (NASDAQ:DITC). According to the 13D filing, Mr. Miller supports Mr. Leehealey and Mr. Sansone – the director candidates nominated by Lamassu Holdings for election to the board of directors at the DITC annual meeting – as “candidates who are independent of management and he seeks to encourage greater attention to corporate governance by all members of the Board of Directors.”

We’ve been following DITC (see our archive here) because it is trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has previously offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” Lamassu has now nominated two candidates for election to the board “who are committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” The stock is up 49.4% from $0.89 to close yesterday at $1.33, giving the company a market capitalization of $35M. We last estimated the net cash value at around $32.2M or $1.23 per share and the liquidation value at around $43.4M or $1.65 per share. While the deterioration in value is a concern, Mr. Miller’s support of Lamassu Holding’s director candidates introduces a new element to the position. We’re inclined to hold on to see how the annual meeting plays out.

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

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Ditech Networks Inc (NASDAQ:DITC) has filed its 10Q for the period ended April 30, 2009.

We’ve been following DITC (see our archive here) because it is trading below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has previously offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” Lamassu has now nominated two candidates for election to the board “who are committed to enhancing shareholder value through a review of the Company’s business and strategic direction.” The stock is up 49.4% from $0.89 to close yesterday at $1.33, giving the company a market capitalization of $35M. We last estimated the net cash value to be $34.3M or $1.31 per share and the liquidation value to be around $47.5M or $1.81 per share. We’ve now reduced our estimate of the net cash value to around $32.2M or $1.23 per share and the liquidation value to around $43.4M or $1.65 per share.

The value proposition updated

DITC has continued to consume cash in its operations through the last quarter, bringing the cash burn over the last year to $22.6M. At April 30, 2009, all of DITC’s short-term and long-term investments were held in corporate notes and asset backed auction rate securities. According to the 10Q, the long-term investments are tied to auction rate securities that failed to settle at auction beginning in fiscal 2008, and for which there appears to be no near-term market. Although these securities would normally be classified as short-term, as they typically settle every 28 days, DITC has reclassified them long-term pending them settling at auction. At June 30, 2009, DITC continued to hold auction rate securities with a par value of $13.7 million. Our updated valuation follows (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):

DITC Summary 2009 4 30In the last 10Q, DITC wrote that it believed its “legacy business to be at or near cash flow break even” which would “begin to be more evident in our financial results in the coming quarters.” That rosy prognosis has not manifest itself this quarter. Maybe DITC management meant the next quarter.

Off-balance sheet arrangements and Contractual obligations

According to the 10Q, DITC has around $4.0M in contractual commitments (including $247M in operating leases and $2.7M in purchase commitments), around $2.6 of which falls due this year and the remainder falling due within the next 3 years. DITC has no other material commitments or off-balance sheet liabilities.

Conclusion

The deterioration in DITC’s value is a concern, but, for reasons we’ll discuss in the next post, we propose to continue to hold DITC in the Greenbackd Portfolio for the time being.

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

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Update June 16, 2009: SOAP has announced that it proposes to liquidate. See our post below.

Update June 3, 2009: We’ve pinned this post to the front page. Any new posts between now and July 4th will appear below this post.

June 1, 2009 marked the end of Greenbackd’s second quarter. It’s time again to report on the performance of the Greenbackd Portfolio and the positions in the portfolio, discuss the evolution of our valuation methodology and outline the future direction of Greenbackd.com.

Second quarter performance of the Greenbackd Portfolio

The second quarter was nothing short of a blockbuster for the Greenbackd Portfolio, up 74.2% on an absolute basis, which was 52.8% higher than the return on the S&P500 return over the same period. A large positive return for the period is heartening, but our celebration is tempered by the fact that it is difficult to avoid a good return in a market that rises 25.0% in a quarter. Our Q1 performance was -3.7% (see our first quarter performance here), which means that our total return since inception (assuming equal weighting in each quarter) is 67.8% against a return on the S&P500 of 11.6%, or an outperformance of 56.2% over the return in the S&P500.

It is still too early to determine how Greenbackd’s strategy of investing in undervalued asset situations with a catalyst is performing, but we believe we are heading in the right direction. Set out below is a list of all the stocks in the Greenbackd Portfolio and the absolute and relative performance of each from the close of the last trading day of the first quarter, Friday, February 28, 2009, to the close on the last trading day in the second quarter, May 29, 2009:

Greenbackd Portfolio Performance 2009 Q2You may have noticed something odd about our presentation of performance. The S&P500 index rose by 25.0% in our second quarter (from 735.09 to 919.14). Our +74.2% performance might suggest an outperformance over the S&P500 index of 49.2%, while we report outperformance of 52.8%. 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. (You can see our summary of Graham’s approach here). 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, and by incorporating the observations of Marty Whitman (see Marty Whitman’s adjustments to Graham’s net net formula here) and Seth Klarman (our Seth Klarman series starts here), we have refined 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. Our analyses are now quantitatively more robust than when we started and that has manifest itself in better performance.

Tweedy Browne offers some compelling evidence for the asset based valuation approach here.

Update on the holdings in the Greenbackd Portfolio

There are eleven stocks remaining in the Greenbackd Portfolio:

  1. VXGN (added March 26, 2009 @ $0.48)
  2. DRAD (added March 9, 2009 @ $0.88)
  3. ASYS (added March 5, 2009 @ $2.78)
  4. CAPS (added February 27, 2009 @ $0.60)
  5. DITC (added February 19, 2009 @ $0.89)
  6. SOAP (added February 2, 2009 @ $2.50)
  7. NSTR (added January 16, 2009 @ $1.91)
  8. ACLS (added January 8, 2009 @ $0.60)
  9. MATH (added December 17, 2008 @ $0.68)
  10. ABTL (added December 11, 2008 @ $0.43)
  11. AVGN (added December 1, 2008 @ $0.65)

The future of Greenbackd.com

We are taking a brief vacation. We’ll be back full-time after July 4th, always reserving the right to post interesting ideas in the interum and update our open positions. If you’re looking for net nets in the meantime, there are two good screens:

  1. GuruFocus has a Graham net net screen ($249 per year)
  2. Graham Investor NCAV screen (Free)

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. Most of the stocks that are currently trading at a premium to the price at which we originally identified them 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 without reading our disclosures and doing your own research). 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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Ditech Networks Inc (NASDAQ:DITC) has filed its 10Q for the period ended January 31, 2009.

We’ve been following DITC (see our archive here) because it is trading well below its net cash value with an investor, Lamassu Holdings LLC, disclosing a 9.4% holding in November last year. Lamassu has offered to acquire DITC for $1.25 per share in cash. Lamassu says that it “anticipates its due diligence requirement will take no more than two weeks and there is no financing contingency.” The stock is up 19.1% from $0.89 to close Friday at $1.09, giving the company a market capitalization of $27.8M. We initially estimated the net cash value to be $37.9M or $1.44 per share. We’ve now adjusted our valuation down slightly to $34.3M or $1.31 per share.

The value proposition updated

DITC has continued to consume cash in its operations through the last quarter, bringing the cash burn in the last three quarters to $15.1M. As of January 31, 2009, DITC also had long-term investments of $8.2 million as compared to $15.1 million at April 30, 2008. These long-term investments are tied to auction rate securities that failed to settle at auction. Although these securities would normally be classified as short-term, as they typically settle every 7, 28 or 35 days, because they failed to settle at auction DITC has reclassified them to long-term pending them settling at auction. As of February 28, 2009, DITC continued to hold auction rate securities with a par value of $13.7M. Our updated valuation follows (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):

ditc-summary-2009-1-31The company believes its “legacy business to be at or near cash flow break even” and this “will begin to be more evident in our financial results in the coming quarters:”

However, we do expect to continue to invest in our newer product offerings, which we believe will help diversify our customer base and hopefully add more predictability to our revenue streams. We expect that the investments in our new products will result in continued negative cash flows from operations until such time that we experience a resurgence of demand for our legacy products closer to their historical levels or our new products gain traction in the market and begin to generate meaningful revenue streams.

This is unfortunate. We think the best use of the company’s cash is its own undervalued stock.

Off-balance sheet arrangements and Contractual obligations

According to the 10Q, DITC has around $5.4M in contractual commitments (including $2.7M in operating leases and $2.7M in purchase commitments), around $2.9 of which falls due this year and the remainder falling due within the next 3 years. DITC has no other material commitments.

Conclusion

We propose to maintain our position in DITC and will continue to hold it in the Greenbackd Portfolio.

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

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The Official Activist Investing Blog has published its list of activist investments for February (links are to the relevant post archive):

Ticker Company Investor
AANB Abigail Adams National Bancorp P.S. D’Iberville Limited Partnership
ABVA Alliance Bankshares Frank Williams
ADLS Advanced Life Sciences Holdings Groundworks of Palm Beach County
AHNA.PK ATC Healthcare Inc Roaring Fork Capital
AMLN Amylin Pharmaceuticals Carl Icahn
APAC APAC Customer Service Ronald Chez
APPA AP Pharma Tang Capital
ATML Atmel Corp. Microchip
ATSG Air Transport Services Group Red Mountain Capital
AVCA Advocat Inc. Bristol Investment Fund
BARI Bancorp Rhode Island Financial Edge Fund
BGP Borders Group Inc. Pershing Square Capital Management
BIIB Biogen Idec Inc. Carl Icahn
BVF Biovail Corp Eugene Melnyk
BWC.TO Bridgewater Systems Crescendo Partners
CAMD California Microdevices Dialectic Capital Management
CAV Cavalier Homes Inc Legacy Housing
CBNJ Cape Bancorp Inc Patriot Financial
CHE Chemed Corp MMI Investors
CHG CH Energy Group Gamco Investors
CLHI.PK CLST Holdings Red Oak Partners
CVG Convergys Corporation Jana Partners
DIN DineEquity, Inc MSD Capital
DITC Ditech Networks Lamassu Holdings
DPS Dr. Pepper Snapple Group Trian Fund
ENZN Enzon Pharmaceuticals inc. DellaCamera Capital Management
EPIC Epicor Software Corp Elliott Associaes
ESHB.PK Earl Schieb Lawndale Capital
GET Gaylord Entertainment Co Gamco Investors
GSLA GS Financial Corp. Riggs Qualified Partners
IPAS iPass Inc Foxhill Opportunity Master Fund
KFS Kingsway Financial Sevices Joseph Stilwell
LCAV LCA-Vision Eduardo Baviera Sabater
LGF Lions Gate Entertainment Corp Carl Icahn
MEDW Mediware Information Systems Cannell Capital
MIM MI Developments Greenlight Capital; Farallon Capital
MIPI Molecular Insight Pharmaceuticals David Barlow
MSPD Mindspeed Technologies AIGH Investment Partners
OFIX Orthofix International Venner Capital
OPTV OpenTV Corp Kudelski SA
ORCC Online Resources Group Tennenbaum Capital Partners
ORNG Orange 21 Costa Brava
PMRY Pomeroy IT Solutions David Pomeroy
PRSC Providence Sevice Corp 73114 Investments
RLH Red Lion Hotels Corp Columbia Pacific Opportunity Fund
SNG Canadian Superior Energy Palo Alto Investors
SNR Sunair Services Dru Schmitt
SSE Southern Connecticut Bancorp Lawrence Seidman
TDS Telephone & Data Systems Gamco Investors; Southeastern Asset Management
TEAM TechTeam Global Costa Brava; Emancipation Capital
TECUA Tecumseh Products Herrick Foundation
TLGD Tollgrade Communications of PA Ramius Capital
TLX Trans Lux Corp Gamco Investors
TUC Mac-Gray Corp Fairview Capital Investment
TUTR Plato Learning Stephen Becker
VNDA Vanda Pharmaceuticals Tang Capital
WEDC White Electronic Designs Corp Wynnefield Partners
WOC Wilshire Enterprises Bulldog Investors

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

About DITC

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

The value proposition

The company’s most recent 10Q tells a horrifying story. The company is consistently burning cash in its operations and burned through more than $8M in the six months to October 31 last year. A substantial (but dwindling) amount of cash remains on the balance sheet (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

ditc-summary

Off-balance sheet arrangements and Contractual obligations

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

The catalyst

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

January 28, 2009

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

Mr. Simpson and Ditech Board of Directors:

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

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

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

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

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

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

Sincerely,

Tim Leehealy

Conclusion

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

DITC closed yesterday at $0.89.

The S&P500 Index closed yesterday at 788.42.

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

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