Knight Capital (NITE) was such a play about a year ago. The company is comprised of three divisions:
1) Global Equity, a market maker and trading execution firm. This has been Knights primary business historically. The division has higher returns in more volatile and active markets.
Results have been all over the board, with an operating margin of less than 10% in 2005 but a high 20's operating margin and soaring revenue this year. Conservatively, this biz could be valued at $8-10 per share.
2) A hedge fund business, managing around $3 billion. Hedge funds are typically valued at around 15% of assets under management, so this gives a value of $450 mil or around $4.30 a share.
3) Corporate, which encompasses their investments. A year ago they had roughly $7 per share in cash and liquid investments-after significant share buybacks in the past year, this is closer to $5/share.
A year ago Knight was selling for around $8.50 per share. I didn't have a crystal ball, but I felt that the cash and investments certainly provided some fairly significant downside protection. The end result: a huge improvement in their global equities business and decent hedge fund returns has boosted the stock to above $19 one year later.
Cryptologic (CRYP) has been hammered as a result of the recent U.S. law against gambling sites accepting credit card transactions. However, the company had a cash hoard of $9.23 per diluted share and derives 70% of their revenue from outside the U.S.
The company has been well aware of the risk of legislative action in the U.S., and thus has been diversifying for five years. In 2005, the company had earnings of $1.46 and free cash flow of $1.89 per share. We own the stock, and have a target price of $30 on the shares.
Portalplayer (PLAY) is another cash hoard candidate. The company sells chips and software for portable music players and some notebooks, and they get about 87% of their revenue from Apple. The stock is down to $11 after an announcement that Apple won't be using PLAY's chip in their new iPod Nano. But the company had $7.64 per diluted share in cash at the end of the 2nd quarter, and was working to diversify their revenue, with a couple of new products that are gaining traction. A business that earned $1.65 in 2005 is now selling for an implied value of $3.36.
We own Portalplayer, and think it has the nice balance of big upside potential and good downside protection. We have a target of $24 on the shares.
Disclosure: Author is long CRYP and PLAY