By David Sterman
When seeking out new investment ideas, I like to run stock screens to find companies that are inexpensive and relatively "safe." Of course, one of the safest kinds of companies is one that is profitable, yet also has lots of cash on the books. In fact, some companies are so cash-rich that even after accounting for any borrowings, their cash can equate to 20%, 30% or even 40% of the entire company's market value.
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If you think about it, that also means these companies are fairly loathed by investors. It's not just that they have so much cash; it's also that their market value has slumped so low that the company isn't really worth much more than that cash.
All of the companies on the list above have real problems. CSCO, for example, has seen its shares fall back to levels seen in 1998, as sales growth has slowed. And all of that cash can't always buy happiness. DELL has made a half-dozen key acquisitions in the past two years, yet analysts still think sales will only grow 4% to 6% in each of the next two years.
Perhaps the poster child of the "cash cowboys" is IACI, which routinely carries more than $1 billion on its books, yet has rarely traded at a premium like other high-flying Internet stocks. IACI started to build or buy an impressive roster of highly-trafficked websites such as Match.com and Evite.com. But the company's founder, Barry Diller, appears to be stuck in the mud recently, throttling back once-promising properties like Ask.com, or cutting losses in properties such as The Daily Beast by merging with traditional media companies (Newsweek in this case). If Diller ever found his footing again, that massive cash balance could put IACI right back into the game.
Yet one cash-rich tech company may be able to turn a bulletproof balance sheet back into a strategic weapon. I'm speaking of ERTS, the video game developer that is undergoing a painful transition but should emerge far healthier when the transition is complete. Electronic Arts is the largest developer of video games in the world, with more than $4 billion of sales in fiscal (March) 2010. Sales likely fell 10% in fiscal 2011 for a fairly obvious reason. Just as was the case with compact discs in recent years, consumers have started to lose their interest in buying packaged video games.
It took Electronic Arts far too long to realize that this was a permanent cultural change, and management appeared slow-footed in its response. Yet in recent quarters the company has gotten wise, pouring a lot more resources into games that can be downloaded digitally. The move is paying off: Electronic Arts is now the second-largest producer of video games played on Facebook and other social media sites. If this were a new young company seen as a social media play, then Electronic Arts would have the makings of a very hot IPO. Some social media companies now look set to reap billions when they come public.
Well, it's too late for Electronic Arts to catch the IPO fever, but it's not too late for the company to boost its reputation on Wall Street. And that's what I see happening. The transition away from packaged video games toward digital downloads should help boost the company's margins. Simply put, it's a lot cheaper to skip the whole printing, shipping and stocking process that typifies traditional media sales.
Electronic Arts likely boosted download sales 30% in fiscal (March) 2011 to around $750 million. Every dollar of those sales carries much higher gross margins, which explains why third-quarter gross margins rose from 51% in fiscal 2010 to 58% in fiscal 2011. It also explains why analysts think profits will start rising much faster than sales -- they think sales will grow just 5% in fiscal (March) 2012, but earnings per share (EPS) should rise nearly 30% to $0.86. That trend of modest sales gains but fast-rising profits should continue in subsequent years as the migration to digitally-downloaded games continues.
A word of caution: Electronic Arts has invested heavily in a new edition of the storied Star Wars franchise, known as "The Old Republic." The massively multi-player online game is expected to do quite well, but repeated development delays have pushed its release out several quarters. That means Electronic Arts' results this summer may be a bit tepid before picking up again in the fall. However, investors may already be well-prepared for the anticipated hiccup.
For a number of years, Electronic Arts' shareholders had been clamoring for a stock buyback. They finally got their wish. The company announced a $600 million share buyback program in February. With all that cash on the books, the buybacks may keep coming even after the current plan is finished. This is a clear-cut example when lots of cash (as a percent of market value) is a reason for optimism. If you're looking for a cash-rich rebound candidate to add to your portfolio, Electronic Arts looks like a good bet.
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold positions in any securities mentioned in this article.