Wednesday, September 20, 2006

Losing Patience with Zapata Corp (ZAP)

Most Zapata investors threw in the towel eons ago. Now, your Cheapstocks editor is on the brink. Truth is, we purchased shares long after many investors had given up. Tales of poor management and too much family involvement by the Glazer clan (there are 5 Glazers on the board) made many investors skeptical of Zapata’s future prospects. We were aware of this situation, but chose to focus on what we viewed as a package of undervalued assets. Chock with cash, and large stakes in two publicly traded companies, Safety Components (formerly SAFY), and Omega Protein (OME), we were confident that value could ultimately be unlocked. Shame on us. Bad management can ruin most companies.

Then the selling began. First, Zapata disposed of its 79% share in Safety Components (formerly traded under SAFY) for $51.2 million. The price was a bit disappointing, but did bring in a lot of cash to Zapata, plus, we always believed the bigger gem to be the company’s 58% stake in fish oil producer Omega Protein. Then, Zapata announced plans to sell its stake in Omega. “At what price” we wondered? Omega has an interesting business but suffered due to Hurricane Katrina. Then there was controversy in the Chesapeake Bay area as to how many tons of Menhaden, the source of the company’s products, Zapata could safely harvest without harming the ecosystem. Both situations hurt Omega, and potentially damaged its allure to potential acquirers.

Then came the long pause. We heard very little about the company’s attempt to sell Omega, which we translated into difficulty finding a buyer. As of 06/30/06, Zapata owned 58 % of Omega, valued at about $94.5 million in terms of the current market cap of Omega. We did not expect Omega to fetch a premium, if anything, large stagnant stakes in publicly traded securities typically sell at a discount.... especially those that are on the block for many months with no takers. And ultimately, a discount it was…

The Transaction
On September 8th, Zapata announced it was selling 9.268 million shares, or 36.8% of Omega Protein, back to Omega for $47.5 million, or $5.125 per share. That’s a 21% discount to the current price. Furthermore, Zapata, which still owns 5.2 million shares, must sell any shares it still owns after 270 days back to Omega for $4.50 per share. The kicker? Omega has 120 days to compete the purchase. Say what? Now the scramble will begin for Zapata to sell its remaining stake. Remember, Zapata could not find a buyer in the first place, and this puts Omega in the catbird seat.

Winners and Losers

The only potential winners that we see are Omega shareholders, who are able to buy back a significant portion of their company at a discount. If Zapata can’t sell the rest to another entity, and Omega can come up with the cash, the discount gets even better for the remaining shares. However, there may be a negative short-term effect on the current market price of Omega, especially if Zapata finds an outside buyer north of $4.50 per share, but south of the current price.

"We are excited about the future at Zapata. The sale of our Omega Protein shares represents an important step as we continue to explore ways to enhance shareholder value."
- Avram Glazer, President and Chief Executive Officer of Zapata

Zapata shareholders lose out on this deal. Once Omega is sold, Zapata has no operating businesses left. True, they may have up to $150 million in cash and little if any debt by our estimates, but bad management is still bad management. What will they do with all that cash? We are afraid to ask. While Zapata’s current market cap is $134 million, conceivably less than the ultimate cash on the balance sheet, that gives us little comfort. We have little confidence left in current management.

Perhaps the best way to play it is sell ZAP, and buy OME.

Previous Zapata Research

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

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