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Wednesday, May 01, 2013

Activist Net Nets



One of the regular screens I run is designed to look for stocks trading near or below their net current assets. This is an approach originally developed by ben Graham with a great deal of success and has been used and tested by many practitioners and academics over the ensuing decades. Finding stocks that trade for two thirds of their NCAV is pretty rare these days but there are a few issues that trade  cheap enough compared to the value of currents assets minus all debt that make are candidates for investment by enterprising value investors.

When I ran the screen this morning I found two interesting stocks worth buying as they have simply become too cheap not to own. Both are former growth stocks that have stumbled and now trade for around the value of the cash, inventory and receivables on the balance sheet. Interestingly both are in the data storage business. Continued delays in corporate IT spending as well as the dominance of companies like Seagate and EMC have hurt the companies but the long term future of the data storage business is pretty bright and I expect both s these to recover over time.

Back in 2009 STEC (STEC) was one of the very few stocks Wall Street was excited about. The stock rose by tenfold in a very short period of time as growth momentum investors piled into the shares. The company has since stumbled badly as demand for its flash memory and solid state drives fell off sharply. The stock crashed back to earth reversing the entire momentum drive move up and has languished in single digits for over a year now.

Business hasn’t gotten any better in recent months. The company saw revenues decline by 40%  in the last quarter of 2012a and the loss was larger than analysts had anticipated. Management has high expectations for its transition away from being entirely OEM driven but in the short term they lowered guidance below what Wall Street was expecting and the shares now trade near the lows for the year. The poor performance has attracted the attention of some activist hedge funds that are staging a fight to replace the board of directors as well as the CEO.

The stock is cheap on a NCAV basis. At the end of the fourth quarter the company had $158 million in cash and total current assets of $244 million. Total liabilities at STEC add up to just $58 million so we have a net current asset value of $186 million. This assigns no value to any of the other assets including the company’s patent portfolio or a 210,000 square foot facility the company owns in Malaysia. The market cap of the company right now is just $209 million. The activist shareholders think that’s too cheap and the company should consider putting itself for sale to unlock the value of the company.  I agree and think a sale of STEC could easily fetch more than twice the current stock price.

The other stock that stood out is one that I already own. I have done very well with shares of Xyratex (XRTX) so far after buying the stock around $7. The stock has run up to $10 and we collected a $2 a share special dividend back in December. The data storage company is still very cheap.  After adjusting the balance sheet for the special dividend Xyratex still has net current assets of $240 million and the market cap is just $272 million. Again this assigns no value to the company’s operations or intellectual property portfolio. The valuation has attracted the attention of Baker Street Capital, an activist investor that now owns 22% of the company. They believe the company is worth something close to $19 a share and management needs to seek strategic alternatives and rework their business plan.  I agree with tier thoughts and think the stock still has quite a bit of upside from the current level.

Searching for stock trading below net current assets can be a futile exercise after an extended market run up but right now these stocks trade near net current assets and have a decent underlying business. They both are being pressured by activist investors to improve the valuation or simply sell the company at a premium. Both are attractive investment candidates right now and appear to be too cheap not to own by enterprising investors.

Originally run as a Real Money Column

2 comments:

Thomas Cal said...

It might be interesting to analyze the historical trend in these firms Net Current Asset Value (NCAV). Is it increasing or decreasing?

Thomas Cal said...

e.g. STEC

NCAV NCAV per share
As of 2011-12-31 256 $5.55
As of 2012-03-31 244 $5.30
As of 2012-06-30 217 $4.66
As of 2012-09-30 202 $4.33
As of 2012-12-31 180 $3.84