I recently posted an article on Peerless Systems Corp (PRLS). In that article, I had (erroneously) considered the company’s prospects only as a licensor of imaging and networking technologies. As I pointed out in that article, given the company’s disclosures regarding consolidation of licensees and the concentration of the company’s revenues, the company’s prospects were likely the reason for the company’s clear undervaluation (Price to TTM Earnings of ~1.4x).
An astute reader pointed out in a comment to that post that I should be thinking about PRLS differently:
Most of Peerless’ earnings were from using their cash to invest in Highbury Financial, which they tried to buy, but were thwarted by Highbury’s management. Peerless did force Highbury to be sold to AMG at a nice profit. I was a shareholder in both companies. Peerless is probably running at breakeven, with recurring revenues of less than 1 million per quarter. The company does have about $3.50 per share in cash. It really is just a play on their ability to invest the cash.In short, rather than considering PRLS simply as a licensor, I should have been considering it’s ability to generate free cash flow from its remaining licensing deals, and then consider the potential use of that cash in the hands of its CEO, a deep value hedge fund manager. Like Eddie Lampert with Sears Holdings and Sardar Biglari with Steak-n-Shake, it often makes more sense to allocate capital away from the industry from which the capital is generated and in the hands of the right person, the returns can far exceed the opportunities in the original industry.
Viewed in this manner, the company looks far more interesting than I previously thought. As the comment above points out, the company has $3.50/share in cash but trades at just $3.30, so the company isn’t reliant on the licensing deals at all – any cash generated from those deals is icing on the cake. Today’s investor gets to buy cash at a discount plus some ongoing income from the licensing deals plus the ability to participate in the upside in future deals. Not bad! Lesson: value opportunities can easily be overlooked without the right mental model for considering the company’s prospects.
I should note one more value investor who refused to reinvest in an industry with poor economics: Warren Buffett with Berkshire Hathaway’s textile mills. Look how that turned out.
Author Disclosure: No position.