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Posts Tagged ‘Stock buy back’

Digirad Corporation (NASDAQ:DRAD) has filed its 10Q for the quarter ended March 31, 2009.

We’ve been following DRAD (see our post archive here) because it is an undervalued asset play with a plan to sell assets and buy back its stock. The stock is up more than 43% since we started following it to close yesterday at $1.26, giving the company a market capitalization of $23.9M. We initially estimated the liquidation value to be around $29.3M or $1.55 per share. After reviewing the Q1 10Q, we’ve left the valuation essentially unchanged at $29.5M or $1.56 per share. The company’s net cash value is around $15.6M or $0.82 per share. DRAD has announced a plan to repurchase $2M of its stock, but it has not yet repurchased a material amount of stock.

The value proposition updated

Our updated estimate for the company’s liquidation value is set out below (the “Book Value” column shows the assets as they are carried in the financial statements, and the “Liquidating Value” column shows our estimate of the value of the assets in a liquidation):

drad-summary-2009-3-31

Balance sheet adjustments

We make the following adjustments to the balance sheet estimates above:

  • Cash burn: The company used $0.6M in cash in the first quarter. We have not included any cash burn in our estimate as DRAD’s first quarter’s cash burn was primarily due to a seasonal increase in DRAD’s inventory and a reduction in its accrued compensation and other liabilities and we do not expect this to be repeated in the second quarter.
  • Off-balance sheet arrangements and contractual obligations: The company hasn’t disclosed any off-balance sheet arrangements in its most recent 10K. The contractual obligations as at December 31 were around $3.0M, around $1.4M of which falls due in the next 12 months..

The catalyst

DRAD’s board has announced a stock buyback program:

The Company also announced that its board of directors has authorized a stock buyback program to repurchase up to an aggregate of $2 million of its issued and outstanding common shares. Digirad had approximately 19 million shares outstanding as of December 31, 2008. At current valuations, this repurchase plan would authorize the buyback of approximately 2.1 million shares, or approximately 11 percent of the company’s outstanding shares.

Chairman of the Digirad Board of Directors R. King Nelson said, “The board believes the Company’s direction and goals towards generating positive cash flow and earnings coupled with an undervalued stock price present a unique investment opportunity. We are confident this will provide a solid return to our shareholders.”

According to the most recent 10Q, the company has not bought back a material amount of stock:

On February 4, 2009, our board of directors authorized a stock buyback program to repurchase up to an aggregate of $2.0 million of our issued and outstanding common shares. The timing of stock repurchases and the number of shares of common stock to be repurchased are in compliance with Rule 10b-18 under the Securities Exchange Act of 1934. The timing and extent of the repurchase depends upon market conditions, applicable legal and contractual requirements, and other factors. During the three months ended March 31, 2009, we repurchased 11,000 shares of our common stock at a cost totaling $11,000.

Conclusion

At its $1.26 close yesterday, DRAD is trading at around 81% of its $29.5M or $1.56 per share in liquidation value. We see no reasons to cease holding DRAD in the Greenbackd Portfolio and so we’re going to maintain the position.

[Full Disclosure:  We do not have a holding in DRAD. 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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Empirical Finance Research Blog has a review of a new paper, Repurchases, Reputation, and Returns, which finds that long-run stock returns are higher for companies announcing buybacks that had substantially completed a previous buyback. In other words, companies with a track record for following through on announced buybacks enjoy higher returns following a subsequent buyback announcement than companies that did not follow through on a previously announced buyback. While that might seem obvious, the paper makes two observations that we find particularly interesting in the context of our investment strategy:

  1. Past buyback completion rates are predictive of future buyback completion rates.
  2. Stocks with high completion rates but low stock returns following previous buybacks enjoy abnormally large returns following a subsequent buyback announcement.

It’s worth remembering that a buyback announcement does not bind a company to undertake a buyback, a situation we encountered recently: RACK suspends buyback and enters agreement to acquire Silicon Graphics; Greenbackd exits position. Companies frequently fail to follow through on announced repurchase plans. Empirical Finance Research cites a 1998 study by Stephens and Weisbach that found that firms on average repurchase only about 80% of the sum announced.

Empirical Finance Research summarizes the paper as follows:

This author measures the level of completion of previous buybacks, as measured by the shares bought as a fraction of the amount specified in the announcement, then uses this to explain how well various stocks do after subsequent buyback announcements. What she finds is that companies that had low completion rates on a previous share buyback experience much lower returns upon the announcement of another buyback. She interprets this as evidence of the company’s credibility, that investors don’t really believe a company about a share buyback when the company has failed to complete one in the past.

First the author confirms that past buyback completion rates are predictive of future buyback completion rates. Next she shows that the stock returns to a company making a buyback announcement are much higher for those with high past completion rates. Companies in the 90th percentile of past completion rate see returns 2.5% higher than those in the 10th percentile of past completion rate in the three days after a the new announcement.

Despite the size of these returns, this isn’t a very good trading strategy, because buyback announcements are clearly unexpected. However, in the next part of the paper the author finds that long-run returns are also reliably higher for repeat buyback companies with high past completion rates. Two year returns are 13.64% for those companies with above-median past completion rates versus 7.43% for those below the median. We should be leery of these results, however as they are not statistically significant.

Next the author splits her sample of repeat buyback companies into quintiles based on the return to the stock during the previous buyback. The two-year abnormal returns to companies in the lowest quintile (those with the lowest returns after their last buyback) are 17.33% after their subsequent buyback. This result is very statistically significant too.

But if we split this quintile in half based on past completion rates, and buy only those stocks with above-median past completion rate, the returns explode to 27.13% for the two year period.

Empirical Research Blog’s takeaway?

The value of this paper is not necessarily in a specific investment strategy but rather in the insight it provides in to a trading strategy we already knew about. I would be hesitant to implement this stand-alone for the practical difficulty in doing so. But any trading strategy that already uses share buybacks as a signaling factor might benefit from an augmentation that accounts for past buyback completion rate.

(Emphasis added)

Quite.

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Rackable Systems Inc (NASDAQ:RACK) has announced that it is suspending its buyback and acquiring substantially all the assets of Silicon Graphics Inc (NASDAQ:SGIC) for “approximately $25 million in cash, subject to adjustment in certain circumstances, plus the assumption of certain liabilities associated with the acquired assets.” Without the buyback, our investment thesis is gone, so we’re exiting our position in RACK. We opened it on March 11, 2009 when it was trading at $3.56, so we’re up 9.0% on an absolute basis. The S&P500 Index was trading at 719.60 when we opened the position in RACK, and closed yesterday at 811.08, which means we’re down 3.7% on a relative basis.

We started following RACK (see our post archive here) because it was an undervalued asset play, and had announced a plan to repurchase almost 40% of its stock. That buyback is now suspended. If the buyback had been completed at the current stock price, the company’s per share liquidation value would have increased by around 17% to $6.72. The acquisition of SGIC’s assets is also almost certain to reduce RACK’s liquidation value. The likely reduction in liquidation value combined with the suspension of the buyback is fatal to our investment thesis, and that’s why we’ve exited. On the whole, a disappointing outcome for us, but the stock is up to $3.95 in after hours trading, so the market clearly disagrees with our assessment.

The Asset Purchase Agreement makes for interesting reading, and the deal may well turn out to be a good one for RACK. It’s certainly buying at the right time and from a distressed seller, which are indicators, but not conclusive, that the deal is good for RACK. It also seems from the Asset Purchase Agreement that RACK is cherry picking the assets it wants and avoiding the liabilities it doesn’t. Whether the deal works for RACK, we have no idea. This sort of analysis is beyond us, so we focus on the liquidation value. Prior to the company entering into the agreement with SGIC, we estimated the liquidation value at around $171.6M or $5.74 per share. Although it is difficult to predict with any precision the effect of the acquisition on RACK’s liquidation value, we are almost certain that it will be reduced by the $25M cash payment plus whatever liabilities are assumed less a smaller increase for the assets acquired. It is likely that RACK’s liquidation value will still be somewhat above its present stock price, but, without the buyback catalyst, our reason for holding the stock is gone, and so we’re out. There’s a chance that the deal will fall over, so we’ll revisit RACK in that event.

The company’s press release is set out below:

Rackable Systems Announces Agreement to Acquire Silicon Graphics Inc.

FREMONT, CA and SUNNYVALE, CA., April 1, 2009 – Rackable Systems, Inc. (NASDAQ:RACK), a leading provider of servers and storage products for medium to large-scale data centers, today announced its agreement to acquire substantially all the assets of Silicon Graphics, Inc. (SGI) (NASDAQ: SGIC) for approximately $25 million in cash, subject to adjustment in certain circumstances, plus the assumption of certain liabilities associated with the acquired assets.

The combined businesses will provide customers with market leading hardware and software technology within large-scale x86 cluster computing, HPC, Internet, Cloud Computing, large-scale data storage environments and visualization platforms across many verticals and geographies. This combination is also expected to result in a stronger global services organization; reaching commercial, government and scientific sectors on a worldwide basis.

“The combined company will be positioned to solve the most demanding business and technology challenges our customers confront today,” said Mark J. Barrenechea, president and CEO of Rackable Systems. “In addition, this combination gives us the potential for significant operational synergies, a strong balance sheet, and positions the combined company for long-term growth and profitability.”

“We have been working very hard to strengthen our company, and today, we’ve taken another big step in that direction,” stated Robert “Bo” Ewald, CEO of Silicon Graphics. “This transaction represents a compelling opportunity for Silicon Graphics’ customers, partners and employees, who can all benefit from the emerging stronger company with better technologies, products and markets reach.”

Barrenechea added, “Together, we believe we will be a much stronger entity with great products and people offering a compelling proposition to compete more effectively in, and across, our collective markets.”

Rackable has signed an Asset Purchase Agreement to acquire substantially all the assets of SGI, and to assume certain liabilities relating to the assets, pursuant to Chapter 11 of the U.S. Bankruptcy Code, under which SGI filed its petition in New York on April 1, 2009. Completion of the transaction is subject to a number of closing conditions, including the approval of the Bankruptcy Court, and other uncertainties. Subject to such conditions and uncertainties, the transaction is expected to close within approximately 60 days. It is expected that SGI’s business operations will continue during the pre-closing period. SGI’s international operations would be part of the sale, but would not be part of the bankruptcy process.

Rackable also announced today that it had suspended its previously announced program including the repurchase of up to $40 million of the company’s stock.

Hat tip to shp.

[Full Disclosure:  We have a holding in RACK. 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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Rackable Systems Inc (NASDAQ:RACK) is a new undervalued asset play with a plan to repurchase almost 40% of its stock at current prices. At RACK’s $3.56 closing price yesterday, the company has a market capitalization of $106.4M. We estimate the company’s liquidation value to be 60% higher at $170.3M or $5.74 per share. If the buy back is completed at the current stock price, the company’s per share liquidation value will increase by almost 25% to $7.00. We’re adding RACK to the Greenbackd Portfolio.

About RACK

RACK is a provider of servers and storage products for data centers. The company was founded in 1999 and is based in Fremont, California. The company’s investor relations website is here.

The value proposition

RACK, as its CEO points out in its earnings release, has had a tough year, burning through $15.7M in the 12 months to January 3, 2009. The company does still have a huge amount of cash and equivalents on its 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):

rack-summary

We estimate the company’s liquidation value to be around $171.6M or $5.74 per share, which is predominantly cash and equivalents in the amount of $172M or $5.75 per share. RACK’s net cash value is around $118M or $3.95 per share.

Off balance sheet arrangements and contractual obligations

The company hasn’t disclosed any off-balance sheet arrangements in its most recent 10Q. The contractual obligations as at September 27, 2008 were around $10.2M, around $2.1M of which falls due in the next 12 months. Those committments are minimum lease payments under the company’s operating leases. The company also had purchase committments in the amount of $30.9M to the end of 2008. We’re not sure what these committments are for the next 12 months.

The catalyst

RACK has announced a radical buy back plan to repurchase $40M of its stock. From the press release:

“2008 was a tough year for our industry and for Rackable. Given our strong financial flexibility with $181 million in cash and investments, we plan on making key investments for 2009,” said Mark J. Barrenechea, president and CEO of Rackable Systems. “First, we plan to invest up to 10% of our cash to expand our product offerings and our sales and service capabilities. Second, the company announced a $40 million share repurchase program today. We believe this is an ideal time to invest in Rackable and that these investments will place the company in a stronger competitive position to gain market share as the economy recovers.”

We estimate that that such a buy back at the present prices will increase the company’s per share liquidation value by almost 25% to $7.00. This is a substantial upside to the current stock price.

Conclusion

It’s great to see company recognizing that its stock is deeply undervalued and taking radical action to capitalize on it. If the market is pricing your stock below its liquidation value, there are bargains to be had by investing in that stock, and we believe it should be your priority. With its stock at $3.56, RACK has a market capitalization of $106.4M, which means it’s trading at a discount to both its net cash value of $118M or $3.95 per share and its liquidation value of $171.6M or $5.74 per share. The cash burn is a risk, but we think RACK is a good bet at this level.

RACK closed yesterday at $3.56.

The S&P500 Index closed yesterday at 719.60 (!).

Hat tip to manny.

[Full Disclosure:  We do not have a holding in RACK. 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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Arrhythmia Research Technology Inc (AMEX:HRT) is a tiny but profitable net net stock with a plan to buy back stock. At its $2.25 close yesterday the company has a market capitalization of just $6.1M. We estimate its pre-buy back liquidation value to be more than 100% higher at around $12.7M or $4.68 per share. If the buy back is completed at the current stock price, we estimate that the company will buy back around 10% of the outstanding stock, which will cause HRT’s per share liquidation value to increase to almost $5.00, around 120% higher than the present stock price.

About HRT

HRT develops medical software that acquires data and analyzes electrical impulses of the heart to detect and aid in the treatment of potentially lethal arrhythmias. HRT’s wholly owned subsidiary, Micron Products, Inc. (Micron) is a manufacturer and distributor of silver plated and non-silver plated conductive resin sensors (sensors) used in the manufacture of disposable integrated electrodes constituting a part of electrocardiographic diagnostic and monitoring instruments. Micron also acts as a distributor of metal snap fasteners (snaps), another component used in the manufacture of disposable electrodes. The company’s investor relations website is here.

The value proposition

In a rarity for a net net stock, HRT is currently profitable. Although it didn’t pay a dividend in 2008, it has paid dividends in the past. In the 12 months ending December 31, 2007, the company earned $1.29M after tax and generated cash from operating activities of $1.47M. The balance sheet looks healthy enough (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):

hrt-summary

HRT’s balance sheet value is predominantly in its property, plant and equipment, to the tune of $16.1M, which we’ve written down by half to $8M or $2.96 per share. The company also has receivables of $3.9M, which we’ve written down by 20% to $3.1M or $1.15 per share, and inventory of $3.7M, which we’ve discounted by a third to $2.5M or $0.91 per share. Deducting liabilities of $3.3M (including $0.7M in debt) from the written down asset value gives us a liquidation value for HRT of around $12.7M or $4.68 per share.

The catalyst

HRT has announced a stock buy back program, which authorizes it to buy back “up to $650,000 of the Company’s common stock from time to time, subject to prevailing conditions and price levels.” No shares have been acquired to date, but we would like to see the company put the buy back into operation. Buy backs effected at deep discounts to intrinsic value, and particularly at deep discounts to liquidation value, create lots of value for remaining stockholders. They also demonstrate that management is alive to the plight of the shareholders’ in a company with a stock languishing at a discount to liquidation value. With the stock at these levels ($2.25), $650,000 buys back around 289,000 shares, which is a little over 10% of the 2.7M shares outstanding. The effect of such a buy back is demonstrated below:

hrt-summary-post-buy-backThe buy back reduces HRT’s total liquidating value from $12.7M to $12.0M, but increases the per share liquidating value from $4.68 to $4.97.

Conclusion

At $2.25, HRT is trading at a 48% discount to its liquidation value of $4.68. If the company undertakes and completes its buy back at the current stock price, HRT’s per share liquidating value will increase to $4.97, which is 120% higher than HRT’s close yesterday. We think HRT is worth a punt at these levels, and we’re adding it to the Greenbackd Portfolio.

Take care with these thinly traded stocks and always use limit orders to buy stock.

HRT closed yesterday at $2.25.

The S&P500 Index closed yesterday at 871.71.

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