Two Compelling 'Cash Hoard' Stocks

Some of my favorite value plays are cash rich companies. Often the business has various degrees of uncertainty (as with most value situations), but the company has little or no debt and a huge cash hoard.

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

Comments

[GreenAB:]

i think argueing with past EPS is not smart.
just have a look at analysts estimates for 2007.

CRYP: +1.21
PLAY: +0.25

both companies see their business shrinking dramatically, but costs remain.

the price targets cannot be justified on this basis.

both picks are just bets that something big might happen (CRYP being bought, PLAY huge customer win).
til then i see no reason for these stocks to outperform.

2006 Oct 10 08:01 AM

[Amit Chokshi:]

Why do you feel PLAY is worth $24 per share when they don't have the Apple business anymore? When it was providing the SOC chips to AAPL it could barely support itself stock wise and picking up incremental business from SanDisk and Creative Technologies won't do much to make up for that loss.

They also rely on just one type of SoC platform that's really targeted towards PMPs. They are going into the cell phone business and there are rumors about Zune picking them up since PLAY's SoC will be in SideShow but the impact of all this is extremely difficulty to quantify. I'm not sure I believe Vista is going to spawn some notebook computer explosion where laptops equipped with sideshow devices will be flying off the shelf. I don't see a lot of differentiation between what SideShow devices can do relative to the next-gen handhelds which can synch to your computer as it is. PLAY's SoC costs more and is a higher end product which is fine but I think as PLAY goes downstream into other devices they'll run up against guys like SGTL and Action Semi that can price them out.

Nonetheless, the cash balance should give you some safety but tech cos can be notorious from going through cash flow to cash burn. Also, the forward estimates are not that attractive, PLAY is really selling for at least 30x next year's EPS.

2006 Oct 10 12:01 PM