Should You Play These Turnaround Candidates?

 |  Includes: DGIT, F, RSH
by: Emerging Growth

Corporate turnarounds can offer exceptional returns to early believers as anyone who invested in Ford Motor (NYSE: F) in 2008 would swear. On the downside, the investment often goes down the drain if the turnaround fails. In this sense, turnaround cases are like leveraged deals - their results are often opposite and to extreme levels. RadioShack Corporation (NYSE: RSH) and Digital Generation Inc (NASDAQ: DGIT) are such cases where stakes are high but rewards can be substantial as well.

RadioShack Corporation is a once big box retailer, which has been reduced to a consumer electronics seller with a market capitalization of just $306 million. With over 20 percent erosion in shareholders' wealth in the last 12 months, there is little going well for the company on the surface. A 45 percent discount to book value and a price-to-sales ratio of 0.08 explains it all. Dig a little deeper and one is compelled to think otherwise. RadioShack's new head, Joe Magnacca, believes there is a chance for the retailer to be back in the business and he is aiming for nothing less than that. However, one of the biggest issues the company is facing is declining number of walk-ins as buyers prefer the online channel nowadays. Among the things that fall in its control is the high debt capital structure with a debt-equity ratio of 1.3. This is not exceptionally high but when seen with working capital requirements for thousands of outlets, it comes across as a big overhang. Magnacca is after revamping RadioShack stores in an attempt to refresh the retailer's image and says the company is working with advisers to figure out ways to strengthen its balance sheet.

Similarly, Digital Generation Inc is a stock that has seen a deep cut of 33 percent over the last year. This Texas-based ad management company lost it big time when it reported a loss of $239 million on sales of $386 million last year. The problems are very much internal to the company and have very little to do with the overall industry, which continues to do well. However, the company offers excellent value, which is reflected in the white knight bid of Alex Meruelo and Meruelo Investment Partners LLC. Together, the activist investor holds over 14 percent and has been pushing for corporate governance changes in the company. As a result, the management recently agreed to appoint an independent board chairman apart from reducing the tenure of newly elected directors to one year. It is still too early to predict a turnaround, but a 26 percent discount-to-book value and a price-to-sales ratio of 0.56 indicate the upside is substantial if Meruelo succeeds.

Disclosure: I am long F. 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.