Back in 2000, I purchased a few shares of Xircom for about $13.69 per share. Xircom was in the business of making network computing products for computers. Their offerings included LAN adaptors, communications cards, and other similar products. In January of 2001, Xircom was acquired by Intel (NASDAQ: INTC) for $25.00 cash per share, or approximately $748 million overall. At the time of its acquisition, Xircom was somewhat profitable, but often under delivered against street expectations. In the end, Xircom was ultimately shut down by Intel.
You are probably wondering why this is even remotely interesting, which is a great question. I had watched the price of Xircom fall throughout 2000 from well over $50 per share. What was interesting to me was that while the stock was around $13.69 per share when I bought it, there was about $9 per share of cash on the balance sheet and it still had positive earnings.
Balance Sheet Cash
In looking for value, this is perhaps one of the clearest signs of value: significant cash on its balance sheet. While this does not necessarily mean that the company is a good investment opportunity, it raises questions about the causes of the situation. If a company is burning through cash at a rapid pace, having significant cash on the balance sheet is a necessity.
Also, if the company has significant amounts of debt that would offset the cash, it is also of limited value. The interesting cases occur when a company appears to have reasonable financials and an enterprise value that is substantially below its equity market capitalization. At times this happens in numerous technology companies largely because they often have no debt and substantial cash resources. This is most easily seen in Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG), Cisco (NASDAQ CSCO), Intel (NASDAQ: INTC), and Microsoft (NASDAQ: MSFT). All equity prices/market capitalizations are from January 31, 2011. All data is pulled from Yahoo!Finance.
|Ticker||Equity Cap||Enterprise Value||Cash||Cash/ Equity Cap||Net Cash||Net Cash/ Equity Cap|
All figures are in billions of dollars except for the percentages. Net Cash is just the difference between Enterprise Value and Equity Value. This approximates Cash less Total Debt.
In looking for potential candidates, I used a basic stock screen to sort out companies with a market capitalization below $3 billion, total debt below $500 million and total cash above $500 million. The rationale for these cutoffs is slightly arbitrary. Smaller market capitalizations increase the potential to find more thinly reviewed and followed companies. Total cash above $500 million ensures that the company has some scale.
The total debt below $500 million means ensures that the enterprise value is less than the equity value like the five previously mentioned tech companies. This provided 74 companies. I then sorted out banks and certain financial institutions and some other companies that did not seem to make sense. This resulted in 37 companies to review. Ranking these remaining 37 companies by return on assets showed 20 companies to have ROAs above 5% and 11 companies with ROAs above 8%. Those eleven companies are listed below:
|Ticker||Name||Industry||ROA||Net Cash/ Equity Cap|
|(GAME)||Shanda Games Limited||Multimedia & Graphics Software||17.5%||30.5%|
|(SOHU)||Sohu.com Inc.||Internet Information Providers||14.6%||20.7%|
|(CBST)||Cubist Pharmaceuticals||Drug Manufacturers, Other||12.9%||69.9%|
|(ELNK)||EarthLink||Internet Service Providers||11.7%||68.5%|
|(AGP)||AMERIGROUP Corp.||Health Care Plans||11.6%||28.5%|
|(AAWW)||Atlas Air Worldwide||Air Services, Other||8.6%||43.3%|
|(CMTL)||Comtech Telecommunications||Communication Equipment||8.5%||78.2%|
|(AEO)||American Eagle Outfitters||Apparel Stores||8.1%||22.4%|
|(AVX)||AVX Corporation||Diversified Electronics||8.0%||29.3%|
Other notable companies on this list included former technology darlings Sycamore Networks (NASDAQ: SCMR) and Tellabs (NASDAQ: TLAB).
Looking for a high ratio of balance sheet cash is an interesting starting point to fundamental analysis. It certainly does not guarantee that there is true value in the stock. Clearly, each company would require additional analysis to determine if it might make a good potential investment. There are potentially very good reasons that a company is trading at just a small premium to its net cash:
- Lack of faith in management's ability to not burn through the cash
- Exposure to significant binary risk, e.g., either this drug ends up with FDA approval or this company has significant financial issues
- Industries that can change rapidly (e.g., technology, pharmaceuticals, biotech, specialty apparel (subject to the whims of consumers.)
- Early stage growth companies that would require significant cash to prove out the business model, but may still not succeed.
- Companies in the harvest phase of their lifecycle that will ultimately fail.
Furthermore, these companies may operate in highly volatile or very low margin environments that demand the company to have significant cash resources or face bankruptcy when there is a meaningful downturn in business. The key question is whether there is the potential that the business will turn around and command a higher value or that the cash on the balance sheet will be distributed to the shareholders.