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Posts Tagged ‘Network Engines Inc (NASDAQ:NENG)’

We’ve decided to exit our position in Network Engines Inc (NASDAQ:NENG) at its $0.56 close yesterday. We opened the position on January 13, 2009 when it was trading at $0.38, so we’re up 47.4% in about two-and-a-half months on an absolute basis, which is a pleasing outcome. The S&P500 Index was trading at 870.26 when we opened the position in NENG, and closed yesterday at 832.86, which means we’re up 51.7% on an relative basis, which is also a good outcome.

We’ve started following NENG (see post archive here) when it was trading at $0.38, which gave it a market capitalization of $16.5M. We initially estimated the company’s liquidation valuation to be around $25.5M or $0.59 per share, but we reduced that estimate to $23.8M or $0.55 per share after reviewing the December 10Q. At its $0.56 close yesterday, the company has a market capitalization of $24.2M, which exceeds our estimate of its liquidation value. We were attracted to the stock because Trinad Management had been pushing the company to “immediately [implement] a share buy-back program.” The company initially demurred and saw its stock sink to all-time lows, but has recently reinstated that stock repurchase program.

Although the company has indicated it will undertake a $5M stock buyback, which will likely push the stock price up further, the stock has reached our estimate of its liquidation value, so the buyback will not increase the per share liquidation value at this level. We’re also mindful that NENG is a perennial net net, and at higher prices than presently prevail, so we think there’s a good chance NENG could be back in net net territory again in the not-too-distant future.

[Full Disclosure:  We do not have a holding in NENG. 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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Network Engines Inc (NASDAQ:NENG) has announced that it is reinstating its stock repurchase program.

We’ve been following NENG (see post archive here) since January 13 when it was trading at $0.38, which gave it a market capitalization of just $16.5M. The stock is up 10.5% since our initial post to $0.42, giving it a market capitalization of $18.1M. We estimate the company’s liquidation valuation to be around 40% higher at $23.8M or $0.55 per share. In November 2007, an activist investor, Trinad Management, pushed the company to “immediately [implement] a share buy-back program.” The company demurred and saw its stock sink to all-time lows. The company has now reinstated that stock repurchase program, which presents the possibility of increasing the company’s per share liquidation value above our $0.55 per share estimate and is good news for stockholders.

The company’s press release is set out below:

NEI RE-INSTITUTES STOCK REPURCHASE PROGRAM

CANTON, MA – March 16, 2009 – NEI (Nasdaq: NENG), a leading provider of application platforms, appliances and services for storage, security and communications software developers, today announced that its Board of Directors has authorized the re-institution of the Company’s stock repurchase program. This program, initially launched on June 12, 2008, authorizes the repurchase of up to $5 million of NEI’s common stock from time to time on the open market or in non-solicited privately negotiated transactions. During 2008, the Company had repurchased approximately $1.1 million, or 1,256,801 shares.

The timing and amount of shares repurchased will be determined at management’s discretion, depending upon its evaluation of market conditions and other factors. The Company plans to use existing working capital and future cash generation to finance the repurchases. On December 31, 2008, NEI reported a cash balance of $13.2 million and had approximately 43.2 million shares of common stock outstanding with a book value of about $1.25 per share.

“The Board’s decision to re-initiate the repurchase program strongly validates its confidence in and the prospects for the Company’s future,” said Greg Shortell, President and Chief Executive Officer of NEI. “We believe that the repurchase of our common stock at this time is an effective use of our capital based on current market conditions and the price of our stock relative to the Company’s balance sheet and enterprise value.”

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

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Greenbackd Portfolio Q1 performance and update

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

First quarter performance of the Greenbackd Portfolio

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

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

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

Greenbackd’s valuation methodology

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

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

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

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

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

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

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

example-summary-2

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

Update on the holdings in the Greenbackd Portfolio

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

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

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

There are fifteen stocks remaining in the Greenbackd Portfolio:

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

The future of Greenbackd.com

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

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

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Network Engines Inc (NASDAQ:NENG) has released its results for the quarter to December 31, 2008. We’ve adjusted our valuation down 7% from $25.5m or $0.59 per share to $23.8M or $0.55 per share. With the stock price at $0.51, we’re going to maintain our position for now, but we’re mindful that NENG is a perennial net net stock and so we might take the opportunity to exit if it gets to our target valuation of $0.55.

We started following NENG on January 13 when it was trading at $0.38, which gave it a market capitalization of just $16.5M. The stock is up 34.2% since our initial post to $0.51, which gives it a market capitalization of $22.0M. In November 2007, an activist investor, Trinad Management, pushed the company to “immediately [implement] a share buy-back program.” The company demurred and saw its stock sink to all-time lows.

The value proposition updated

NENG’s Q1 10Q shows an increase in cash, which seems to be largely as a result of reducing accounts receivable and inventories (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):

neng-summary-q4

Conclusion

We are inclined to exit NENG if it gets to our $0.55 valuation. It’s a perennial net net stock, so we think there’s a good chance NENG will be back in net net land again. As we pointed out in our earlier post, Jonathan Heller of Cheap Stocks-fame mentioned it back in October 2005 in a list of the Top 20 Market Cap Companies Trading Below Net Current Asset Value. It was then trading around $1.30 against a net current asset value of around $1.31. Investors buying back in October 2005 had plenty of opportunity to unload the stock at a profit while it traded up to $3.17 in March 2006. We’re planning to do the same again, but at $0.55.

[Full Disclosure:  We do not have a holding in NENG. 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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Network Engines Inc (NASDAQ:NENG) is a perennial inclusion on lists of net net stocks and so it should come as no surprise to see it back in net net land. In November 2007, an activist investor, Trinad Management, pushed the company to “immediately [implement] a share buy-back program.” The company demurred and has now seen its stock sink to all-time lows. In after-hours trading yesterday, NENG was up a little from those lows to $0.38 (it closed yesterday at $0.40), which gives it a market capitalization of $16.5M. We estimate its liquidation value at around 55% higher at $25.5M or $0.59 per share.

About NENG

NENG develops and manufactures application platform solutions that enable original equipment manufacturers, independent software vendors, and service providers to deliver software applications in the form of a network-ready device. The company offers application platform customers a suite of services associated with the design, development, manufacturing, brand fulfillment and post-sale support of these devices. It produces and fulfills devices for its customers, and derives revenues primarily from the sale of value-added hardware platforms to these customers. These customers subsequently resell and support the platforms under their own brands to their customer base. The company’s investor relations website can be found here.

The value proposition

NENG’s earnings and cash flow are patchy (its most recent 10K can be found here). Earnings have fallen in each of the last five quarters from $1.8M in the 2007 September quarter to -$9.7M in the 2008 September quarter. Cash from operating activities has been as high as $10.6M in the 12-months ending September 2007 and as low as -$5.4M in the preceding 12 months. As a result,   there is some vestigial value on the balance sheet (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):

neng-summary

NENG has $29M in receivables that we’ve written down by 20% to $23.2M or $0.54 per share, inventory of $21.4M that we’ve discounted by 33% to $14.3M or $0.33 per share and cash in the amount of $10M or $0.23 per share. The company has no debt. Deducting liabilities of $23.7M or $0.55 per share, we estimate NENG’s liquidation value at around $25.5M or $0.59.

NENG’s most recent 10K specifically sets out that it is not party to any special-purpose or off balance sheet entities created for the purpose of raising capital, incurring debt or operating parts of its business that are not consolidated into its financial statements.

The catalyst

Trinad Management filed its original 13D in November 2007 disclosing a 6.4% holding in NENG and attaching the following letter to NENG’s board:

The Board of Directors Network Engines, Inc.
25 Dan Road
Canton, MA 02021
Dear Board Members:

We support Greg Shortell and the new management team at Network Engines and are encouraged by their accomplishments to date. We believe the focus of the sales and marketing efforts on diversifying the company’s customer base is yielding results and should allow for the continued generation of substantial free cash flow from operations.

Furthermore, we approve of management’s decision to acquire Alliance Systems, Inc. In our estimation, this acquisition should significantly increase shareholder value. It is our belief that the Company can realize increased sales through product portfolio expansion and cross selling opportunities. At the same time, synergies of the acquisition have provided Network Engines with the opportunity to significantly grow its business. The post-acquisition Network Engines should achieve economies of scale and will likely incur integration savings during FY 2008. The Alliance Systems acquisition and the shift in sales and marketing focus should result in an improved ability to successfully execute its business strategy.

Taking these positive events and Network Engines’ current and long term commitments into account, our financial analysis suggests that the Company currently has approximately $10 million in cash on its balance sheet and no funded indebtedness. In addition, our conservative projections indicate that the Company will generate an additional $10 million (or more) in free cash flow during the next 12 months. Accordingly, we strongly believe that this board and management has an obligation to dedicate a portion of its cash reserve and free cash flow to projects which have the greatest return to shareholders such as a share buy-back program. We request that the Board of Directors consider whether shareholder returns on other proposed uses of these excess funds are indeed superior to a share buy-back.

The Company’s stock hit a new 52 week low today (November 15, 2007) despite the impressive efforts and results posted by this management team. We appeal to the Board of Directors to consider immediately implementing a share buy-back program as it is in the best long-term interest of both the Company and its shareholders.

We believe that the Company is significantly undervalued and that a share buy-back program would improve investors’ overall perception of Network Engines’ equity value. Such a program could result in a reduction in the relative value discount currently applied to Network Engines’ stock by the investor community, by amongst other things demonstrating that this Board has confidence in the Company’s ability to execute its business plan. If the Board were to apply the same valuation metrics to its own stock as it did to the recently completed acquisition of Alliance Systems Inc., they would undoubtedly conclude that at these price levels the Company’s shares represent an equal or greater value than Alliance Systems. Most importantly, a smartly implemented buyback program could allow the company to materially reduce its number of outstanding shares thereby generating long term shareholder value in the most tax efficient manner. As a significant equity holder and long term investor, this is of far greater value then any short term impact to share price.

We encourage the Board of Directors and management to consider and adopt this strategy immediately and speak with other shareholders of the Company who may be equally frustrated and share our views. We would be willing to meet with the Board of Directors and work collaboratively to assist with the development of a long-term value creation plan that would benefit all shareholders.
Sincerely,

/s/ Jay Wolf
Trinad Management, LLC

Trinad Management continued to buy stock in NENG, disclosing in an amended 13D a slightly increased 6.98% holding in July last year.

Conclusion

As we mentioned in the introduction, NENG is a perennial net net stock. Jonathan Heller of Cheap Stocks-fame mentioned it back in October 2005 in a list of the Top 20 Market Cap Companies Trading Below Net Current Asset Value. It was then trading around $1.30 against a net current asset value of around $1.31. Investors buying back in October 2005 had plenty of opportunity to unload the stock at a profit while it traded up to $3.17 in March 2006. NENG’s stock has since dropped pretty consistently to its present $0.38, but its liquidating value has not fallen as far. At $0.59 per share, NENG’s liquidation value is 55% higher than its stock price, which is a significant margin of safety. We’re adding it to the Greenbackd Portfolio at $0.38.

NENG traded after hours yesterday at $0.38.

The S&P500 Index closed yesterday at 870.26.

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