Tuesday, June 27, 2006

Paying for Illiquidity
Another Company Heads Toward Delisting: By Choice

Advanced Nutraceuticals
Ticker: ANII
Price: $3.00
Mkt Cap: $14.2 million
Ent Val: $17.8 million
Ent Val/Ebitda: 4.6
P/E: 8.52

Your Cheap Stocks editor realized today just how off-the beaten path his portfolio building antics have become after listening to Charles Schwab’s automated quote line. You know, Schwab account holders, the familiar voice that will read through your list of current holdings, should you so desire? You know you’ve entered no-mans land when this great voice gives you a ticker only for some of your holdings, and not the company name. Not even Schwab knows the names of these companies. Not even the great voice!

That’s certainly the case for our latest acquisition, Advanced Nutraceuticals Inc, a tiny, but profitable Denver based manufacturer of supplements and vitamins, through its NY based subsidiary Bactolac Pharmaceuticals. Fiscal year end 2005 sales were $22.9 million, up 30 % from 2004’s $17.6 million. Net income was $1.9 million in 2005, down from $3 million in 2004. The company is dependent on 2 unnamed customers for 24.5 % of sales (Q1 2006). 2006 Q1 sales of $6.7 million were up from $5.5 million from the same quarter last year. Net income was essentially flat at $590,000

As of Q1 2006, the company had $1.9 million in cash, and about $5.4 million in short and long term debt. Book value per share as of 3/31/06 was $2.93, so the company does trade at about book value. However, on a tangible book value basis (excluding goodwill) that figure drops to just $1.33. Not a bad balance sheet, but not stellar.

Going Private
Based on fundamentals alone, it’s doubtful that we’d have taken a position in ANII. Not that the fundamentals are bad, they are actually quite good. But what caught our eye was the fact that ANII is yet another company seeking to avoid Sarbanes Oxley and SEC filing, essentially going private while maintaining a listing on the pink sheets. (An avid Cheapstocks reader alerted us to ANII’s intentions a few months back, after reading the proxy) We find these situations rather interesting, for a couple of reasons: Companies going this route save money by avoiding SarBox, and SEC filing in general, and since many of the companies are very small, the savings can be relatively significant. Furthermore, key personnel, such as the CFO, often spend a great deal of their time on compliance related issues. Going private removes these constraints, allowing management to spend more time on growing the business(We know, that's only positive if management is competent). Furthermore, going private may telegraph that management feels the company is undervalued, and wants a bigger piece of the pie.

The Downside
Going Private is not a free lunch for shareholders. Despite the potential positives, there are negatives. First of all, companies effecting the GPT transaction often shut off communications with shareholders. Remember, they no longer are required to file with the SEC, so financial information can be difficult to acquire—even if you are a shareholder. Some such as Avoca, are very forthcoming, as we’ve previously reported, but as shareholder, you may be on your own. Another major downside is that in order to meet the requirements to avoid SarbOx, and SEC filing—getting the number of shareholders below 300—the fallout is that liquidity disappears.

Getting There
There are a few ways to shrink to less than 300 shareholders, the one we see most often is the reverse stock split. In this transaction a company will split 1 for 100 (Avoca), 1 for 500 (as ANII intends, 1 for 5 (Scheid Vineyards), or any way it believes will be effective. Once the split occurs, this will leave many shareholders with fractional shares which the company redeems for cash—hence the reduction in shareholder roles. But that’s not the only reduction—with a reverse split comes a reduction is shares outstanding. Depending on the magnitude of the split, this can be an overwhelming reduction in the float. Avoca, for instance now has just 8 thousand shares out. If ANII’s proposed split commences, they’ll have just 9 thousand. Bye-bye liquidity, bye-bye daily trade volume, not that there was much before anyway. Post-split, shares are difficult to find, and difficult to sell. Hence, these companies are only for those with longer time horizons, patience, and the wherewithal to contend with a lack of information.

Going private could also be negative if management has an agenda not in the best interest of shareholders. Since they are no longer beholden to SEC reporting, financial shenanigans will be easier to hide. Finally, these companies virtually close the doors to further financing by shutting down communications with the outside world.

A Calculated Risk
We were compelled to take a small position in ANII. The combination of decent fundamentals, and the prospect of going private sealed the deal. Please note the words “small position”. The rules and benefits of diversification still apply here.

The Proxy

The company’s recent proxy outlines the reasons for the proposed de-listing; this is a move that must be approved by shareholders. However, in this case, it’s a moot point because management owns nearly 69% of the outstanding shares.

Rather than drone on, we thought it beneficial to delve into the actual proxy. The following is directly from the proxy:

Why are we proposing the reverse split?

The purpose of the reverse split is to reduce the number of shareholders of record below 300, which will enable us to terminate the registration of our common stock under the Securities Exchange Act.

By terminating our registration under the Securities Exchange Act, we hope to:

• Achieve significant savings in ongoing legal, accounting and other administrative costs associated with being a public company and related to the reporting process and shareholder communications required by the Securities Exchange Act;

• Avoid significant expenses and efforts that would be necessary for us to comply with additional procedures relating to internal control that otherwise are required by year-end 2007 under the Sarbanes-Oxley Act and SEC regulations; and

• Enable management, employees, and the board of directors to focus their efforts on the operations and management of the Company’s business, rather than the reporting processes.

The primary purpose of the reverse split is to reduce the number of holders of our common stock below 300, which will enable us to suspend filing periodic and annual reports with the SEC and to no longer incur the significant costs of complying with the reporting requirements of the Securities Exchange Act. The elimination of those requirements will allow management to refocus the time spent preparing reporting documents and engaging in securities law compliance activities to the pursuit of operational and business goals. In considering the proposed amendments, our board of directors considered the benefits and costs to us and our shareholders set forth below.
• We believe that as a result of the reverse split we will be able to realize cost savings of at least approximately $200,000 annually by eliminating the requirements to make periodic public reports and by reducing the expenses of shareholder communications, including legal expense ($60,000), audit and accounting expense ($40,000), printing expense ($15,000), postage ($8,000), data entry, stock transfer and other administrative expenses ($5,000), as well reduced staff and management time ($75,000) spent on reporting and securities law compliance matters. In addition, we will avoid the costs of initial compliance with the internal control over financial reporting systems requirements of the Sarbanes-Oxley Act, currently expected to be required for public companies of our size by year-end 2007, which are estimated to range from $150,000 to $200,000, and continued annual costs of related compliance and reporting in amounts not determined. Our board of directors believes that the increased disclosure and procedural requirements will result in continuing increased legal, accounting and administrative expense, and diversion of board of directors, management and staff effort without a commensurate benefit to our shareholders.

• Given the limited trading in our common stock, our board of directors does not believe that the costs of reporting are justified. Our earnings are sufficient to permit our expected growth and we are not dependent on access to the capital markets to obtain additional financing. If it becomes necessary to raise additional capital, we believe that there are adequate sources of additional capital available through private or institutional sales of equity or debt securities, although we recognize that there can be no assurance that we will be able to raise additional capital when required, or that the cost of such capital will be attractive.

• The reverse split is expected to result in the cashing-out at a price determined to be fair by our board of directors of the equity interest of approximately 2,950 record shareholders (98%) of our common stock who own less than 500 shares of our common stock on the record date.

• Our board of directors has determined that the price to be paid for the shares of our common stock to be cashed out in the reverse split is fair, and that the transaction is fair to our remaining shareholders.

• The reverse split will enable small shareholders to divest themselves of their positions without the expenditure of efforts disproportionate to the value of their holdings, without transaction expenses and at a price which reflects the current market value of our common stock.

• The reverse split and deregistration will have an impact on the ability to trade our common stock, as our common stock will not longer be available for quotation on the OTC Bulletin Board. Trades will continue to be the result of direct communications between buyers and sellers, although a market may develop in the “Pink Sheets.”

• Operating as a private company will allow management to better focus its efforts on the operations of the company.

• The reverse split and deregistration will permit a significant number of our shareholders to continue as shareholders and to enjoy the benefits of share ownership, including dividends, when, as and if declared, and potential capital appreciation. Currently, under our senior credit facility we are prohibited from paying dividends. At the same time, we will be relieved of significant expense and diversion of management time and effort, which may result in improved operating efficiencies and reduced need for additional compliance-related employees, and in potentially increased net earnings.
Effects of the Reverse Split on Cashed-Out Shareholders
Upon consummation of the reverse split, shareholders owning less than 500 shares immediately prior to the reverse split will:
• Receive $3.20 in cash, without interest, per share;

• Not be required to pay any brokerage commissions or other service charges in connection with the reverse split;

• No longer have any equity interest in the company and therefore will not participate in our future potential earnings or growth, if any, as a shareholder; and

• Be required to pay federal and, if applicable, state and local income taxes on the cash amount received for the purchase of fractional shares. See “Special Factors–Certain Federal Income Tax Consequences.”

Effects of the Reverse Split on Remaining Shareholders
The effects of the reverse split on shareholders owning 500 or more shares immediately prior to the effective time of the reverse split will include:
• Continued Ownership of Shares. Shareholders who own 500 or more shares immediately prior to the effective time of the reverse split will continue to be shareholders of the company;

• Increased Ownership Percentage. Remaining shareholders will have an increased ownership percentage in the company as a result of the reverse split;

• Decreased Liquidity. The liquidity of the shares of our common stock held by remaining shareholders will decrease by the reverse split due to the reduced number of shares of common stock outstanding and the fact that our common stock will not longer be available for quotation on the OTC Bulletin Board; and

• Decreased Access to Information. If the reverse split is effected, we intend to suspend our reporting obligations to the SEC under the Securities Exchange Act. As a result, we will no longer be subject to the periodic reporting requirements and the proxy rules of the Securities Exchange Act.

The Good, the Bad and the Ugly
We think the company does a pretty good job of outlining it’s reasoning behind the transaction. As always, enter at your own risk. We'll update you on our progress.

*The author has a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Monday, June 19, 2006

The Top Ten Net/Nets by Market Cap

We admit, this is not our favorite research to distribute here at Cheap Stocks, but it happens to be popular with our readers. This new list has several new names on it, and your editor still holds LKI and DPII.

What's most interesting about this current list is the fact that most of these companies are cash rich. In fact, four of the ten currently trade at a negative Enterprise Value (OLGC, DPII, INHX, IBPI). Yet, only one is making money, LKI, which trades at 42 times earnings.

The net/net area is still weak these days, (compared to 2001-2003, that is) in terms of sheer numbers of companies trading below NCAV, and in terms of quality. Time was Circuit City, Deb Shops, Ambassadors Intl, Duckwall Alco, Silverleaf Resorts, and GIII Apparel, among others, graced this list. Currently, we are left with primarily unprofitable companies burning through relatively large piles of cash at different frequencies.

Not that we are wanting a longer list--typically, you'll get just that during prolonged market downturns--and we are not advocating such conditions. In the meantime, we'll keep turning over rocks.

Company: Audiovoxx
Ticker: VOXX
Current Price: $12.24
Industry: Electronics
Mkt Cap: $274
NCAV: $322.2
Cash: $178.6

Company: Orthologic Corp
Ticker: OLGC
Current Price: $1.62
Industry: Biopharma
Mkt Cap: 66
NCAV: 70.4
Cash: 73.8

Company: Network Equipment Technologies
Ticker: NWK
Current Price: $2.75
Industry: Biopharma
Mkt Cap: 67
NCAV: 67
Cash: 86.3

Company: Lazare Kaplan
Ticker: LKI
Current Price: $7.97
Industry: Diamonds
Mkt Cap:65
NCAV: 79.6
Cash: 8
See last week’s report

Company: Discovery Partners
Ticker: DPII
Current Price: $2.47
Industry: R&D
Mkt Cap: 65
NCAV: 79.5
Cash: 79.5
See Report

Company: Inhibitex
Ticker: INHX
Current Price: $1.82
Industry: Biotech
Mkt Cap: 55
NCAV: 64.9
Cash: 77.2

Company: Zomax
Ticker: ZOMX
Current Price: $1.52
Industry: Electronic Tech
Mkt Cap: 49
NCAV: 57.2
Cash: 42.9

Company: Qualstar Corp
Ticker: QBAK
Current Price: $3.02
Industry: Electronic Storage
Mkt Cap: 37
NCAV: 42.4
Cash: 34

Company: Strategic Distribution
Ticker: STRD
Current Price: $3.02
Industry: Distribution Services
Mkt Cap: 36.6
NCAV: 39.8
Cash: 79.5

Company: Intrabiotics Pharmaceuticals
Ticker: IBPI
Current Price: $3.52
Industry: Distribution Services
Mkt Cap: 33
NCAV: 48.8
Cash: 48.8

*The author has positions in DPII and LKI. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Saturday, June 10, 2006

Looking Through the LENS:
Another Cheapie? Or Just a Cigar Butt?

Company: Concord Camera
Ticker: LENS
Price: $.66
Avg Volume: 80000
Market Cap: $18.9 million
NCAV: $44.6 million
Mkt Cap/NCAV: 2.36
Enterprise Value: -$9.0 million

I admit it, at first glance, there really is not much to like about this company. Judging by its current price, and fact that its enterprise value is negative, most investors hate it too. Concord Camera has had it’s share of problems over the past several years, including lawsuits for patent infringement, as well as suits brought by shareholders.

A Terrible Business
Florida based Concord is in the disposable (single use), 35mm, and digital camera business. That’s not a great place to be, given the intense competitive environment, and competition that includes some big names such as Canon, Fuji, Hewlett-Packard, Kodak, Olympus, Nikon, Sony, Pentax, Konica/Minolta, Panasonic, Samsung and Vivitar. Manufacturing and assembly of Concord products is done in China, and products are sold worldwide. The company ceased manufacturing digital cameras in the fourth quarter of 2005, and now purchases these from outside manufacturers. Company products include the following brand names: Concord, Keystone, EasyShot, Le Clic, Fun Shooter, Polaroid, and Jenoptik

Dependent on Contracts and Retailers
This micro-micro cap company is highly dependent on a few retailers, namely Wal Mart, and Walgreen which represented 22.6% and 11.7% of 2005 sales. Dependence on one or two retailers is not always a good thing, especially for a tiny struggling company that has very little pricing power (at least thats what we suspect). Wal Mart could take its business elsewhere pretty easily, a move that would devastate this company.

Terrible Results
Concord continues to lose money quarter after quarter, and sales continue to fall. The company has not turned a profit since 2003. FY 2005 sales were $174.3 million, down 14% from 2004s $203.1 million. 2005's net loss ballooned to $44.9 million from $31.2 million in 2004.

Whats to Like
If you are ready to short LENS at this point, we certainly wouldn't blame based on the companies seemingly dismal situation. But, hold on. There is something to like about this company afterall. Despite mounting losses, a tough operating environment,
LENS is awash with cash, on a relative basis, anyway. Amd the company is currently trading well below net current asset value.

The Balance Sheet
As of 4/01/06, the company had $29.5 million in cash and short term investments. (There's an additional $8.2 million in restricted cash, but we'll leave that out). That equates to $1.00 per share in cash. Furthermore, the company is trading well below its NCAV: Here's the calculation:

Current Assets: $79 million
Current Liabilities: $32.6
Long Term Liabilities: $1.7
NCAV: $44.6 million
Mkt Cap: $18.9 million

In Ben Graham's terms, this is a true net/net, because it trades for less than 2/3 of NCAV. (That certainly does not mean that Graham would like this company!)

Negative Enterprise Value
One other intersting fact is that LENS' Enterprise Value(EV) is negative. For anyone new to the concept of EV, it is a more meaningful measure of market valuation than market cap. EV represents the entire value the market (or acquirer) places on a company. It represents all claims common and preferred shareholders, and bondholders have on a given company. It is calculated by adding market cap, prefered equity, and debt, then subtracting cash & short term marketable securities.
A negative EV sends a strong signal: The market has little or no hope, and would rather give it away for nothing. (This is theoretical of course)

Here the EV calculation for LENS:
Market Cap: $18.9
Debt: $ 1.6
Preferred: 0
Cash & ST MS: $29.5

EV: ($ 9.0)

What this tells you, is all else being equal, buyers of LENS are being paid to purchase shares. In reality, its not quite that simple, but you get the point.

Institutional Ownership
Surprisingly, there is a decent amount of institutional ownership, just over 24%.
Here's the top 5:
Dimensional Fund Advisers: 6%
Howson Tatersall: 3.3%
SC Fundamental LLC: 2.7%
HSBC 1.8%
UBS O'Connor 1.4%

This one is not for the feint of heart. There are a whole lot of negatives that might ultimately sink this tiny ship. However, if the company can keep it's cash burn rate low (was about $4 million last quarter, that includes changes in cash and S/T MS), and find a way back to profitability, this may be an interesting story. The company has very little debt ($1.5 million ST, no long term), so interest payments are not a huge weight. Furthermore, there were some encouraging signs in Q3; while the company still had a sizable loss ($4.7 million), that is down sharply from the same quarter last year ($14.8 million). So, maybe we are reaching a bit, but we are just looking for a pulse. A deep value investor might look at this company and say that for $.67 per share, they are getting in return $1.00 in cash and ST MS, plus $.50+ in tangible assets (LT assets, PP&E). We know theres more to the story. We know that a patent infringement case might get in the way, or a canceled contract might send sales further. Still, we'll be watching, trying to see if there's any life left.

Please do your own due diligence with this company; read the 10K or recent 10Q's, and as always proceed with caution. And remember, the principles of diversification apply to net/nets too.

*The author does not have a position in this stock. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.

Sunday, June 04, 2006

Update on 1/26/06 Column: Top 10 market cap companies trading below NCAV

We last published a top 10 list such as this back in January, and this column proved to be extremely popular with our readers. Below is the original list, with returns since January.

Company: Trans World Entertainment
Ticker: TWMC
January Price: $4.77
Current Price: $6.23
Return: +30.6%
Industry: Retail/music & video
Report Available

Company: Dominion Homes
Ticker: DHOM
January Price: $10.2
Current Price: $10.49
Return: +2.8%
Industry: Home Building

Company: Lazare Kaplan
Ticker: LKI
January Price: $8.64
Current Price: $8.25
Return: -4.5%
Industry: Diamonds
See last week’s report

Company: Discovery Partners
Ticker: DPII
January Price: $2.5
Current Price: $2.56
Return: +2.4%
Industry: R&D
See Report

Company: Axonyx
Ticker: AXYX
January Price: $.94
Current Price: $.95
Return: +1.1%
Industry: Biotech

Company: Praecis Pharmaceutical
Ticker: PRCS
January Price: $4.32
Current Price: $5.57
Return: +29%
Industry: Medical/Pharma

Company: Pharmos Corp
Ticker: PARS
January Price: $2.15
Current Price: $2.41
Return: +12.1%
Industry: Drug Delivery

Company: Remec Inc
Ticker: REMC
January Price: $1.3
Current Price: $1.14
Return: -12.3%
Industry: Wireless Equipment

Company: Intrabiotics
Ticker: IBPI
January Price: $3.65
Current Price: $3.42
Return: -6.3%
Industry: Medical-Drugs

Company: Peak Intl
Ticker: PEAK
January Price: $2.49
Current Price: $2.89
Return: +16.1%
Industry: Semiconductor Equip

There you have it. The companies on the January 26 list returned an average of 7.1% since that report. Next week, we'll re-run the list to see who the current top 10 NCAV companies are.

*The author has positions in DPII and LKI. This is neither a recommendation to buy or sell this security. All information provided believed to be reliable and presented for information purposes only.