By Jason Seo
Cash rich technology stocks have been targeted by hedge funds because these companies trade at a discount to their peers. Carl Icahn has been forcing Apple (NASDAQ:AAPL) to return more capital to shareholders. Since cash isn't generating any meaningful returns in this low interest environment, share repurchases will lead to increased earnings per share and, hopefully, higher share prices. In this article we will bring a cash rich stock to your attention that is likely to outperform the market over the next 12 months.
During fourth quarter several hedge fund managers increased their holdings of Polycom Inc. (NASDAQ:PLCM), including activist investor Jeffrey Smith of Starboard Value, who more than doubled his stake and now owns 3.9% of the video and voice conferencing solutions provider. George Soros, Cliff Asness and Philippe Laffont are also major shareholders. Our research has shown that small-cap stocks that are popular among hedge funds tend to outperform the market by a large margin on average (read the details here).
2013 was a volatile year for PLCM, which faced the departure of its product /services chief in February, followed by the resignation of its CEO due to expense irregularities in July. Post the appointment of a new CEO from ATM producer NCR Corp. (NYSE:NCR) in December, the distraction of management turmoil has been put in the backburner and investors have turned their attention back to the company's earnings, which have continued to meet or beat consensus estimates in recent quarters.
Amid the headline-grabbing chaos, PLCM did announce a new $400M share repurchase plan (22% of its market capitalization) in early September. Interestingly, the third quarter was also significant when Starboard first bought shares of the company, scooping up 2.85M shares and making it the 13th largest holding of the 13F portfolio. We do not think this was a coincidence, as Starboard more than likely began amassing its stake in late July when the stock dropped more than 18% over two days following the news of the CEO departure. Shortly thereafter, PCLM increased the size of its board to seven by appointing two new board members and announced it had used up $285M of the repurchase authorization (for 27.4M shares) and was entering into an accelerated repurchase program for the remaining $115M (for 8.0M shares). Again, this development comes on the heel of Soros initiating a 9.4M share position in the company during 4Q13 (not to mention Starboard more than doubling its existing holdings).
With these two heavyweight investors acquiring significant stakes during the quarter, further capital return actions could be on the horizon, especially in light of PLCM's high cash balance (30% of its balance sheet vs. 18% for its peer group of communications equipment companies) and free cash flow yield (11% vs. 2%). Valuation-wise, the stock trades at an EV / EBITDA multiple of 7.4X vs. the peer group median 9.1X; a narrowing of the discount implies a stock price of $15.50, or 19% upside from current levels.
Disclosure: I am long AAPL.
Business relationship disclosure: This article is written by Insider Monkey's writer, Jason Seo, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.