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Imation Corp: Following In The Path of Kodak?

December 16, 2011 | About:
Imation Corp (NYSE: IMN) is a global developer and marketer of branded storage products such as CDs, DVDs, flash drives and magnetic tapes. It was a subsidiary of 3M Company (NYSE: MMM) until it was spun-off in the mid 1990s, and over the last decade has seen its business enter secular decline as consumers transition to the cloud. While revenues have declined since 2008, actual organic growth has been somewhat elusive as the company has made expensive acquisitions in each of the last six years.

Earnings have been negative since 2006, which has contributed to the nearly 90% decline in its share price since then. As I write this post in mid November, the company is trading at an all-time low around $6.11. A reader emailed to suggest I take a look, since the company’s free cash flows over the last five years average $85 million (versus a market capitalization of just $235 million) thanks largely to declining working capital demands as the business shrinks. Additionally, for the current market cap, someone could buy the business and receive $233 million in cash, paying just $2 million for the business itself and the remaining $161.5 million in net tangible assets.

Sounds like a pretty good deal, right? On a closer look, perhaps not.

It appears the company is committed to continuing its acquisition binge, completing two acquisitions in fiscal 2011 which contributed to the stunning $70 million decline in cash and investments (a 23% reduction in nine months). Shareholders are understandably upset. From the recent conference call (emphasis added and edited for length. Read the original document for everything):

Rich Rubin – Hawkeye Capital – Analyst

Good morning. Clearly we are disappointed with the numbers. Our stock is down 10% today and we have seen the cash go from 305 at the end of 2010 to 233 at the end of September.We have seen tangible book go down. So I want to focus on the things that I think are really important here.

How have we spent the money on acquisitions? Can you talk us through the multiples and how you guys see those acquisitions working out? Then also on the restructuring savings and when we are going to see that hitting the numbers?

Paul Zeller – Imation Corporation – VP and CFO

… We have made some investments, which gives to your second question about what are the multiples and the valuation dynamics of those investments?

We have talked in the past, Rich, about kind of two classes of investments, one which is going to be smaller, that’s more about acquiring technology in a platform and an example of that would be the ENCRYPTX acquisition or the ProStor InfiniVault acquisition. The other side of the spectrum will be a larger acquisition where we are fundamentally buying a pretty existing revenue base and earnings potential. I would put the couple of acquisitions in the security space kind of in between the two.

We are buying into a rapidly growing market reality and security that we are very excited about.That is relatively in its infancy relative to the ultimate opportunity so there are real revenues, not profitability currently. But there’s I think a great opportunity as we’ve built the number one position in the kind of removable security space. And we think that’s a very strong platform for the future not just in that market category, but we think the technology is leverageable across a broader array of products as well.

Rich Rubin – Hawkeye Capital – Analyst

Right. But you can’t tell us the numbers on how you’ve spent our cash. So as shareholders you can use these terms like progress and they may sound great.We’re not seeing anything.We are just seeing cash leave the balance sheet. We are seeing no insiders buying shares in the open market, so that shows us how confident you are.

And it just — we have seen nothing to prove that this strategy is going to work. And yet your shares had been trading below cash and you don’t aggressively buy back your shares.You know, it’s a disappointment. And none of you guys buy back shares. None of you buy in the open market.

Mark Lucas – Imation Corporation – President and CEO

Rich, this is Mark.You are very consistent in your comments to me. So I appreciate that. I totally understand what you are asking for.We have outlined very clearly I think what the strategic direction of this Company is, how we are going to best leverage our assets to increase shareholder return.We have said we are in a state of transition for 2011 and much of 2012.We plan to continue down that path. Now as we (multiple speakers)

Rich Rubin – Hawkeye Capital – Analyst

You are following the path of Kodak (NYSE: EK).You are going to spend and (multiple speakers) and take a shot with shareholders’ money and you have a ton of cash.The stock trades well below liquidation value. And you are doing nothing about it.You’re just taking shots at acquisitions.

Mark Lucas – Imation Corporation – President and CEO

… This is not a short-term play for us. This is a long-term transformation that is going to eventually build tremendous value for shareholders. I understand your point of view. I think perhaps we just disagree with it.
What begins with a reasonable question on the part of Mr. Rubin (how are your acquisitions with shareholder money performing?) ends with a clear distinction between the interests of shareholders and those of insiders. Management is unable to provide any clear metrics to support its contention that these acquisitions will enhance shareholder value, and instead points to wholly irrelevant metrics (e.g. number one position, increasing revenues, strong platform) that provide no evidence of future returns.

Mr. Lucas’ final statement essentially boils down to “trust us and things will work out.” After five years of acquisitions and tangible book value declining 40% and the share price falling 86%, things have not worked out and shareholders have every reason to demand their capital back. Unfortunately there seems to be little chance of this happening, and this appears to be due to a conflict between insider and shareholder interests.

According to the last proxy statement, insiders own 6.09% of the company, reflecting an economic value of $14.34 million. One would expect this level of investment to create an alignment of interests with other shareholders, however these same insiders earned total director and executive compensation totaling more than $11 million last year alone. If it is personally so profitable to continue operating, then why would you ever move to dissolve (or shrink through a share repurchase), even if continuing to operate destroys shareholder value? It is the board’s responsibility to represent shareholder interests, yet it does not appear to be taking the necessary steps. Additionally, while management proclaims its confidence in this strategy, Mr. Rubin correctly points out that insiders are not buying shares personally.

I agree with Mr. Rubin’s assessment of the situation and based on IMN’s current valuation it appears the market also agrees. Given the conflicts of interest, I will pass even though it is trading at such a depressed price relative to its cash balance. Also, one more point on the company’s apparently high free cash flow: one must take the company’s repeated acquisitions into account and look at free cash flow after acquisitions, which paints a very different and negative picture than appears at first glance.

What do you think of IMN?

Author Disclosure: None.

Talk to Frank about Imation Corp.

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.

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