I’ve written about Navarre Corporation (NASDAQ: NAVR) before. It does a combination of publishing and distribution. For publishing, it sells computer software like Mavis Beacon Teaches Typing and Hoyle PC Gaming. However, ~90% of sales are derived from the distribution business.
The last time I wrote about this company, it had announced that it would sell its FUNimation division for $24 million cash. As noted in that post, NAVR was carrying FUNimation on its books for $28.5 million, so this seemed like a strange sale price, that begged the question: if the division was worth less than it was being carried at, then why hadn’t management taken an earlier write-down?
In fact, management HAD already taken an earlier write-down – in 2009, they took an $81.1m impairment of the FUNimation division, so why wasn’t that enough? Regardless, even if management had written it down earlier by $4.5 million, this still would not have been enough since, according to the recent 10-K, the assets sold were not $28.5 million, but rather $30.68 million, and the net proceeds were not $24 million but $22.54 million (after $1.46m transaction costs). So rather than having to take a $4.5 million pre-tax loss related to this transaction, it had to take an $8.14m pre-tax loss. Quite a difference, especially for a company with a market cap of $66m.
Once NAVR decided to sell FUNimation, it began listing it as “Discontinued operations” and from the net income disclosures for discontinued operations, we can see that FUNimation was indeed profitable. Usually profitable companies don’t sell at a discount to book value (though, they frequently trade at a discount to BV). So we are left to ask, why would a company that has already recognized the problems with a division (as evidenced by the earlier impairment) neglect to take a further write-down if management believed the division to be worth less than carrying value? Why wait until a sale transaction to announce to the world that the division was worth significantly less? It would seem to me that the options are:
- they either failed to communicate the true value of the asset, or
- they failed in their duty to safeguard the shareholders’ assets and extract the real value out of the asset
I like to think that the Board has shareholders’ interests in mind, and that the assets were worth more than the sale price (after all, it seems the sale price of $24 million represented just 6.9x the $3.89 million listed under income from discontinued operations this past year, which is slightly down from the $4.18m listed for last year). So what explains the discount? Perhaps is had something to do with the sale transaction.
In “Note 3 Discontinued Operations” of the recent 10-K, the company notes:
In connection with the sale, the Company entered into an agreement to act as FUNimation’s exclusive distributor in the United States on a continuing basis, and will also act as FUNimation’s logistics and fulfillment services provider…
These types of agreements are sometimes used as part of the sale of a business, however they can be used to impact the income statement and the statement of cash flows. In the book "Financial Shenanigans: How to Detect Accounting Gimmicks & Fraud in Financial Reports," by Howard Schilit (which I will be reviewing in detail over several posts soon) the author notes that there have been instances of companies that have sold divisions for less than their true value in exchange for agreements that provide ongoing revenue. This allows the seller to shift some of the purchase price from “below the line” (a one-time gain appearing below operating income on the income statement) up into operating earnings as improved future revenue (this makes operating earnings, which are the focus of many investors, look better). Additionally, it allows the seller to enhance its Statement of Cash Flows by shifting some of the sale of the division (a Cash Flow from Investing) toward Cash Flows from Operations. To be clear, I don’t know if this is the case here, but if it is one would expect to see improved financial statements next quarter.
What are your thoughts?Disclosure:
I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.