Seeking Alpha
CFA, long/short equity, macro
Profile| Send Message|
( followers)  

Insignia Systems, Inc. (NASDAQ:ISIG) specializes in in-store advertising programs for consumer packaged goods manufacturers. Back in early February, the company had a market cap of about $120 million vs. no debt and cash and investments of about $12.5 million. Then on February 9th, the company announced that it had settled some major litigation (Read about it here) that it had brought a decade ago (emphasis added):

On February 9, 2011, Insignia Systems, Inc. (the “Registrant”) entered into a confidential Settlement Agreement and Release with News America Marketing In-Store, LLC (“NAM”). The Settlement Agreement and Release settled the Registrant’s outstanding lawsuit against NAM, which was pending in United States District Court, District of Minnesota. Under the terms of the Settlement Agreement and Release, NAM paid the Registrant $125,000,000, and the Registrant paid NAM $4,000,000 in consideration for a 10-year exclusive arrangement for the sale and placement of signs with price by Insignia in NAM’s retailer network.

Given the enterprise value of ISIG before the announcement was around $14 million less than the net amount it would receive from the settlement, one would expect ISIG’s shares to skyrocket.

But it didn’t happen. The company’s share price barely budged following the announcement and has outright collapsed since then. Is the market making a big mistake?

Let’s start with assessing how much cash the company actually received.

Gross Receipt: $125 million
Less: NAM agreement 4 million
Less: Legal fee 31.25 million
Less: Performance Bonuses 3.988 million
Less: Taxes $34.7 million
Net Gain $51.06 million

The legal fee seems astronomical, but this is the result of the company choosing a contingency agreement to pay 25% of any win to the lawyers. This is supposed to avoid ongoing legal fees which can add up over a decade of litigation.

But did it work?

If you go back through previous 10-Ks, the company was incurring significant legal fees each year. For example, looking at the 2010 10-k you find this disclosure (emphasis added):

During the year ended December 31, 2010, the Company incurred legal fees of $1,851,000 related to the News America litigation. Management expects the amount of legal fees and expenses that will be incurred in connection with the lawsuit against News America will be significant throughout the first quarter of 2011 due to trial preparation, start of the trial and settlement activities. Legal fees and expenses are expensed as incurred and are included in general and administrative expenses in the statements of operations.

In fact, I went through the last 10 years of 10-ks, and here is the breakdown:

2000 ? Amount Not Disclosed
2001 ? Amount Not Disclosed
2002 $978,000 Possibly includes other lawsuits
2003 $766,000 NAM specific fees disclosed in 2005 10-k
2004 $2,712,000
2005 $1,085,000
2006 $935,000
2007 $1,758,000
2008 $4,086,000
2009 $1,753,000
2010 $1,851,000
1H 2011 $1,018,000
Total: $16,942,000

I am not quite sure what to say about this, but I was somewhat shocked to see the amounts paid each year AND the ultimate contingency fee. Aren’t these supposed to be either-or? Lesson: the lawyers always win.

On a more positive note, the company used the bulk of the remaining cash in a shareholder friendly manner. The company completed a special dividend of $2 per share, and approved a $15 million share repurchase plan (later revised up to $20 million). Six months later, more than $14.8 million of shares have been repurchased and $31.3 million of dividends have been paid out.

There are some other good things about ISIG. When you remove the after-tax value of the legal expenses in the table above, the company’s profitability increases fairly dramatically. Over the last five years, its average net income was $2.7 million. Over the same period, average litigation expense was $2.077 million. Take off 36% in taxes, to get an average of $1.33 million. Add the two and you would see average profitability become $4.03 million, or 49% higher.

Despite this, the market has continued to ignore ISIG. The company’s shares have been on a downward spiral for the past six months, sending shares down 50% from the days after the special dividend payment (again, this is despite the increased demand from the company’s share repurchases). Right now, you can buy the company for less than the cash on its balance sheet, and going forward you would have an unlevered company that should be significantly more profitable due to the elimination of its historically significant legal fees.

What do you think of ISIG?

Disclosure: No position.

Source: Insignia Systems, Inc.: Trading For Less Than Cash