In the letter, the firm said:
"Were the Board to consider a return of capital to shareholders, as I suggest it does, my sense is that some combination of a one-time dividend (say $2 per share) and a committed, long-term share repurchase program would effectively balance the needs of the corporation and those of the outside passive shareholders like TAM."
NOTE: Another large Electro Scientific shareholder, Nierenberg Investment Management, has been pushing the company to issue a special one-time cash dividend.
A Copy of the Letter:
It was a pleasure meeting recently with you, John and Craig. In the spirit of being constructive, I wanted to share some thoughts and recommendations regarding our conversation on share repurchases and extraordinary dividends as a means of returning value to shareholders. As you know at September 30, 2006 Third Avenue Management (“TAM”) owned 4.5 million shares of Electro Scientific Industries’ common stock (“ESI Common”). TAM has been a long-term and supportive shareholder. While uninterested in short-term stock price performance, we remain a keen observer of the business. We believe the company remains overcapitalized, and that a return of capital, in some form, ought to be considered very seriously.
From the TAM point of view, the facts, observations, and recommendations are these:
•Our preference is for management to use excess resources in the business to grow the per share value of the business. Only if management concludes that it is not likely to use that surplus capital in such a manner should it consider returning that capital to shareholders (i.e., the corporation comes first);
• A strong balance sheet is a competitive advantage, and is especially critical in cyclical industries like the ones in which the company participates;
• In the 10 years we have owned ESI Common, the company has never made a large acquisition using either cash or stock, and has carried large cash balances during the entire period, suggesting that the company does, indeed, have an element of surplus capital;
• The company’s operations have - over the course of several business cycles - been self-funding;
• In the past few years the company appears to have earned less than 4% on its portfolio of cash and securities, which comprise nearly one-half of the company’s assets. While net interest income appears to be rising, it makes little economic sense to retain so much capital earning sub par returns;
• A committed share repurchase program requires management to make a judgment about the value of its share price since, presumably, management will not pay more than “fair value” for its shares or more than the company is worth. Share repurchase programs are most effective when management acts opportunistically in this regard;
• As the attached analysis suggests, the benefits of a long-term share repurchase program likely accrue more to long-term holders of ESI Common, in the form of higher reported EPS and the avoidance of taxes at the shareholder level, in contrast to a large, one-time dividend whose benefits would benefit even short-term oriented investors;
• A share repurchase program and an extraordinary dividend almost certainly carry different “signals” to the market (i.e., share repurchases suggest undervaluation of the shares, a dividend may connote limited growth opportunities);
• A share repurchase program can be implemented in various forms, including Open Market Purchases, Fixed Price Tender Offers, Dutch Auction Tender Offers and Privately Negotiated Transactions;
• A share repurchase program, in contrast to a one-time dividend, may be modified in the case of a prolonged industry downturn, or should an extraordinary growth opportunity present itself, and the company needs capital;
• Were the company to need capital, it appears that it has the requisite and properly-oriented shareholder base that might participate in a rights offering, a cost effective, quick and shareholder friendly approach to capital raising;
• Given the company’s extensive international business, it’s not clear how much of the company’s cash resides outside the United States and how much would need to be repatriated in order to pay a large dividend. On the surface it does not seem to make sense to pay U.S. taxes on repatriated funds simply to return capital to shareholders;
• It’s likely that a large, one-time extraordinary dividend would correlate with a smaller market capitalization. Less clear, perhaps, is the effect of a long-term share repurchase program on the company’s market capitalization;
• A share repurchase program, if large enough, may adversely affect share liquidity, in contrast to a dividend, which would have no such effect on the stock, per se.
Were the Board to consider a return of capital to shareholders, as I suggest it does, my sense is that some combination of a one-time dividend (say $2 per share) and a committed, long-term share repurchase program would effectively balance the needs of the corporation and those of the outside passive shareholders like TAM.
Should you wish to discuss these ideas further, please don’t hesitate to contact me.
Curtis R. Jensen
Co-Chief Investment Officer