Dirt Cheap Emerson Could Soon See Catalyst

Mar.21.13 | About: Emerson Radio (MSN)

Emerson Radio has a century long history, starting as a phonograph company in 1912 and evolving into a manufacturer of low to mid priced consumer appliances and electronics today. Emerson sells nearly all product through Target (NYSE:TGT) and Wal-Mart (NYSE:WMT), but earns much of its income by licensing its brand name to Funai (televisions) and some other licensees.

The investment case for Emerson is not one of future prosperity and growth. The company is a cigar butt, plain and simple, albeit one with very measurable value mostly in the form of cash and working capital, a decent stream of expected future earnings, and very little invested capital at risk. Emerson outsources all production; it has sold off all of its owned real estate, and has a total of $200k in PP&E.

Emerson's Embedded Value, 3/31/13 Estimates
Curr Shr Pr Cash/shr, net* License Rev** NWC Biz Value Total***
$1.57 $2.15 $0.28 $0.10 $0.50-2.00 $2.62-$4.12
Click to enlarge

*Net of $0.14/shr in debt and preferred
**Projected brand licensing revenue based on contract with Funai expiring 3/31/15 and some ancillary licenses, assumed net of tax.
***Net of potential taxes on repatriation of foreign profits.

Emerson's working capital has been dropping rapidly as nearly all of it is attributable to its Wal-Mart relationship, which is waning. The license revenue estimates are conservative as they are nearly all contracted. Funai has been a licensee since 2001, so there's a pretty good chance that the relationship is extended after the 3/2015 expiration. There's also the potential for additional license deals, and Emerson's business with Target has been stable (and we figure it to be more profitable than Wal-Mart, which is notoriously tough on its suppliers). Emerson would likely have to pay some U.S. corporate income taxes should it repatriates foreign earnings (to pay a cash dividend, for example), and we figure this could amount to as much as $0.41/shr). With conservative assumptions and assuming repatriation, Emerson should have $2.20/shr in net cash two years from now. Future additional license revenue, earnings from their retail relationships, and a possible sale of the brand or business would all be gravy.

Why is Emerson so cheap? The cause is corporate governance concerns, to put it very mildly. After Hong Kong listed Grande Holdings purchased majority control of Emerson in 2006 (their basis, adjusted for a $1.10 dividend paid in early 2010, is about $3.50/shr), Grande conducted a series of intercompany loans and related party transactions, resulting in lawsuits against the company and ultimately a settlement requiring by-law changes, repayment by Grande of modest amounts, and more independent directors. Grande and Emerson Chairman Christopher Ho has had control of Emerson since 2006, and Ho has a long history of self-dealing and less than arms-length corporate actions.

But Grande filed for bankruptcy in June 2011, and since then FTI consulting has been restructuring and winnowing down Grande's assets. Most of Grande's assets are in Asia, and tiny Emerson -- at present a $43 million market cap, and of course publicly traded -- is at this point quite non-core relative to Grande's manufacturing operations. FTI has handled deals of this sort before, in many cases selling off non-core assets via private placement. We believe that FTI is a great choice for the case of Grande due to its size, integrity, and willingness to do what is required. FTI has offices in the U.S. which could facilitate a potential private placement or offering of the Grande stake. Investors in the past have been turned off to Emerson on the assumption that Grande's majority stake will never escape Ho's grasp. But Christopher Ho may not have the resources to keep control of Emerson. Furthermore, Emerson's CEO, Duncan Hon, just resigned from his position with Grande.

Emerson paid a $1.10/shr dividend in early 2010 but since then has been hoarding cash. The ideal move from a shareholders perspective would be for Emerson to pay out a substantial dividend, as much as $2/shr in the near term. While this may result in delisting from the NYSE, Emerson could use several tools to reduce the size of its shareholder base and thus "go dark", which would reduce operating company expenses. With its size, this is probably not a company which should be public.

The primary risk at this point is that Grande and Ho retain control after Grande is done restructuring and Emerson's cash hoard is squandered. But with shares at a sharp discount to net asset value, most of which is cash, the company remaining solidly profitable, and little on the balance sheet which could be impaired, the numbers clearly make sense. A potential change in control is the catalyst which would close Emerson's discount.

Disclosure: I am long MSN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.