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Selecting the Right Mental Model: Peerless Systems (PRLS)

January 20, 2011 | About:
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.

About the author:

Frank Voisin
Frank is an entrepreneur who owned four restaurants by the time he was twenty. He sold his businesses and returned to school, completing a concurrent Law / MBA degree. At the same time, he successfully completed all three levels of the CFA exams. He now invests full time with a focus on value investing. Frank Voisin writes about value investing topics at http://www.frankvoisin.com.

Visit Frank Voisin's Website


Rating: 2.9/5 (9 votes)

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Comments

brentstephens15
Brentstephens15 - 3 years ago
deleted comment (I see the answer I was looking for)
Alex Morris
Alex Morris - 3 years ago
Frank,

Thank you for the article, definitely will take a closer look. One question though for you. From the most recent 10-Q:



On August 26, 2010,
ourBoard of Directors approved a tender offer to acquire its common stock at a cash price of $3.25 per share inan amount up to $45 million. The tender offer was commenced on October 5, 2010 and expired on November 4, 2010.Giving effect to shares properly tendered pursuant to a notice of guaranteed delivery, a total of 13,214,401 shares were properly tendered and not withdrawn in the Offer at a total purchase price of $42,946,803. We completed the purchase of shares on November 10, 2010. The offer was undersubscribed and we purchased all properly tendered shares. As of November 11, 2010, the Company had 3,357,519 shares outstanding.



What are your thoughts on this stock repurchase? Naturally there are less shares which means a larger stake per share, but the cash position is down to about $12M after that. Would like to hear your thoughts. Thanks
trb2114
Trb2114 - 3 years ago
Hey Frank,

This is Thomas from Columbia commenting. I'm going to email you back about EMH soon. I was looking over Peerless. Thanks for the post. Yeah the company is simply an acquisition vehicle with a pile of cash. Using the recent 10Q and subtracting out the recent share repurchase (that's minus $42.9 Million in cash and minus 13,214,401 shares) the company has $3.30 per share in cash, and $2.05 net cash per share after all liabilities. Net current assets (current assets after minus all liabilities) of $3.40 per share. So the backstop of liquidation value is there, but it's not great.

Now that Peerless has milked its Highbury Financial investment, it's not entering a break-even phase but instead entering a cash burn phase until it acquires something (boards full of investment bankers and money managers are expensive)... so the clock is on. I'm sure the board, and Mr. Brog will find something to buy but they better do it fast. There is no other value and no NOL (net loss carryforwards) to utilize upon acquiring another firm.

I'll look deeper into Peerless. If this kind of situation interests you, check out Cadus (KDUS). This is a company with the same story. A pile of cash looking for an acquisition. BUT in this case, Cadus trades for $1.39 and has $1.85 net cash after liabilities, and other $1.75 in NOLs. Therefore, before taking into account being able to leverage up on the acquired firm, Cadus is could be worth $3.60 per share ($1.39 in cash plus the $1.75 in NOLs). Again I think Cadus is more bang for your buck, but I'll look closer at Peerless to see if I'm missing anything.

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