Optimal Group: Home-Run Value Trap

Aug.13.07 | About: Optimal Group, (OPMR)
Optimal Group (NASDAQ:OPMR) reported earnings this week. Overall, earnings were lackluster showing a slight revenue decline and only $0.05 net earnings. There was no worthwhile update to the status of the $19.2 seized by the Justice Department.

Management presents adjusted earnings which do not include expenses for amortization or stock options. Optimal is amortizing the cost of its acquisition of the minority ownership stake in FireOne plc. The charges for amortizing the intangible assets and goodwill will affect earnings for at least the next five years. For the second half of 2007, Optimal will amortize $6,160,000 and $11,497,000 in 2008.

Going forward, I'll be paying attention primarily to revenue growth and management’s adjusted earnings minus investment income minus options expenses. The amortization is a result of the online gambling regulation in the US and was somewhat out management's control. Investment income was $3,477,000 for the first half of 2007. It is not a measurement of the performance of the core business.

Based on cash per share and book value, Optimal seems like the most home run value stock in the market. But management is going to have to grow the business before anyone really starts to take notice. Otherwise, you're investing on the hope of a reversal of the gambling ban in the US.

It’s hard to assign an appropriate multiple to a company that's had a major business disruption in the last 2 years and zero quarter-to-quarter revenue growth. Adjusted earnings - investment income - stock options, for the last two quarters was $2,493,000 and $2,884,000 respectively, which represents 13.5% growth q/q. Per share earnings are equivalent to $0.101 and $0.118 respectivelyrepresenting earnings growth of 14.4% growth q/q due to a decline in options and warrants affecting dilution.

But wait, last quarter there was an interesting tidbit that needs to be factored into earnings:

We were pursuing the recovery of funds withdrawn from our bank account by one of our credit card suppliers for various service charges assessed pertaining to periods prior to December 31, 2001, on the belief that these charges were largely unsubstantiated. Our claim, which was being pursued through legal recourse, was settled and received in July 2007 for $3.0 million and is included in accounts receivable in the consolidated balance sheets at June 30, 2007. As a result of the settlement, we recorded a gain of $1.6 million representing the difference between the settlement amount and the carrying amount of the receivable. The gain has been recorded as part of selling, general and administrative expenses in the consolidated statements of operations.

Optimal was able to recover $1.6 million dollars from one of their credit card suppliers. The $1.6 million was included in the SG&A portion of the statement of operations. WTF? Now we’ve got to back out the $1.6 million gain from SG&A. $2,884,000 – $1,600,000 = $1,284,000 ($0.052/share). So according to MY adjusted earnings calculation, there was a 50% decline q/q?

SG&A obviously did not come down as much as it appears. As a result, the decline in revenue equals a drop in earnings. I was going to be crazy and break-out the earnings and try to get a forward P/E for the second half of 2007 and 2008. But since revenues are stagnating and earnings declined, there ain’t shit to break-out.

I reduced my position in this stock by 1/3 before earnings because the action in the stock was abysmal. Today, its getting a swirly. This stock is a value trap in plain sight, with no near-term catalysts to reverse this slide. The selling today is overdone, but with no upside catalyst, a bounce is all you can hope for. I’ll look again when the stock gets closer to trading for 1x cash, $4.41/share. Until management starts to grow the business, it ain't worth much more.

OPMR-1 yr

Disclosure: Author has a long position of 50 shares in Optimal Group.