Tom Shohfi

Sigma Designs to Acquire CopperGate

The drop in ROE has been reflected with a 80% decrease in share price since the 2007 high (with 35% ROE). Furthermore, ROE is distorted because of the cash stockpile - take half the cash out and see what ROE looks like. I can't make the argument that management has made an effective use of that cash - the jury will be out for a while on the latest transaction. I care about cash flow, not ROE. Bank executives are often compensated on ROE... that's enough to demonstrate how misleading the metric is, and that's particularly true for the tech sector.


On Oct 17 08:37 PM pone wrote:

> Except for two exceptional years in 2007 and 2008, SIGM rarely has
> a return on equity of more than about 8% average, looking back over
> the last seven years. Is this really the kind of growth against
> equity that anyone should get excited about?

Sigma Designs to Acquire CopperGate

Nice analysis, Tom. I had also considered writing a commentary piece on the transaction. As SIGM shareholders, we can take solace in the fact that management did not spend $200-$250M for CopperGate. That number had floated around before the deal was announced. SIGM had $192M of cash/equivalents and and short term investments as of Aug 1st (plus another $40M in long term auction rate securities), so there is still a nice a cash stockpile of $100M after the transaction. That's still probably too much working capital, but management may be less likely to do another repurchase after doing so last time at such a high price per share. I for one would like to see them announce a new buyback of around $30M (which is 10% of shares out prior to transaction, 30% of cash and 75% of 3 Year average FCF) to fight some of the short selling that has kept the stock down.

Frankly, I think the synergies are much more top line oriented than with costs. Geography will be one basic challenge to trimming R&D expense. Then there's the differences between the two technologies - they're complementary in use but not so much in development. The deal is structured to retain and provide incentives for CopperGate's existing talent - a plus for the new company but goes contrary to R&D expense reduction. SIGM's management must believe that the deal will offer a more complete IPTV suite that can keep Broadcom from taking a large percentage of market share, particularly with AT&T. Their offerings fit into AT&T's strategy more so than Verizon and its fibre to premises offerings.

I have a detailed model that I'm adjusting to the deal, but here's a back of the envelope calculation that I believe is fairly conservative:

Disc Rate 13.00%
FCF Addition (mm) $22
Pre Transaction Post Transaction
Long Term Yearly FCF $40 $62
FCF Perpetuity $307.69 473.0769231
Net Cash 192 100
Target Market Cap 499.6923077 573.0769231
Shares Out 26.8 30.8
Target Price 18.64523536 18.60639361

Basically, the new company would have to increase FCF by $22M (over 50%) to equal the prior valuation of SIGM. That's an aggressive assumption and a likely contributing factor to the stock's sell off. If the contribution is $15M in long term FCF, which is more realistic in my opinion ($10M in income is already there and it's bound to grow at a double digit rate), the estimate drops from $18.60 to $17.

We'll have to see how quickly they can integrate and provide the combined offering to customers. Broadcom has been looming, but, as many SIGM longs believe, it has already been priced into the equation.

S&P upgrades Conseco (CNO) to stable from negative after hedge fund manager John Paulson says he intends to increase his stake to 9.9% and buy up to $200M of the $293M in convertible notes the insurer is selling; shares now up 25.1%.

Wow... S&P is sure showing the value of their equity and debt analysis. They're letting John Paulson and the rest of the buy side elite do the jobs of their analysts!

In Defense of the Rating Agencies, Once Again

Before mass-securitization and the rise of CDOs, the rating agencies integrity was based on the credibility of due diligence behind their debt ratings. When they destroyed the meaning of those ratings by hastily slapping seals of approval on garbage CDO, CDO^2 and other products, that integrity disappeared and their biggest cash cows have been crippled beyond repair. Moody's and S&P have been trying to diversify their business models because they know the game is over.

This process was in effect before securitization. Corporate bond prices predicted ratings changes long before they actually occurred. The ratings system had been made obsolete by market efficiency. We already have the mechanism to eliminate the role of ratings all together: credit default swaps. With a liquid, well regulated CDS market priced on an exchange to mitigate counterparty risk, periodic spread averages can be used to determine credit quality more accurately and efficiently than through the antiquated rating agencies model. We can use one of the culprits of the financial meltdown to make credit markets more stable and functional without the nonsense of "traditional" credit ratings.

Clorox (CLX +2.1%) call option trades have hit an eight-year high amid new speculation that the company's a target for Procter & Gamble (PG). The most active options were $60 Oct. 16 calls, with Clorox at $58.95.

Are investors fully considering regulatory risk? Clorox owns huge market share in the US in a number of areas that P&G operates in (www.wikinvest.com/stoc...). Even if the deal goes through, will the DOJ allow it? I believe there would be some serious resistance.

With stakes high at the Mobilize 2009 conference, Motorola (MOT +1.9%) fills in details on its Android (GOOG) bets, with a social-networking platform called MOTOBLUR and a new phone model for the holidays.

Blur? That is almost the worst name for a phone that I've ever seen. Great, a phone with a social network integrator - not revolutionary. Plus, as the presentation says, it has "Good Voice Quality." Not quite a strong pitch. This is not the saving grace that Motorola needs to make itself relevant again in the smartphone arena. But, as their exec Jha says "this is a starting point, the beginning of a volley over the next 12-18 months." Guess we'll have to wait for the next iteration. The last Motorola smartphone that featured this type of event was the Windows Mobile powered Q. One thing is for sure, this is another indication of how irrelevant Microsoft is in the mobile OS market today. The mobile market is supposed to be the biggest avenue of growth for search <bing>.

Why Is Vonage Up 500% in 5 days?

Despite it's trek down to sub-$100M market cap, VG has always had excellent liquidity which is making these monstrous moves even more baffling. Getting access to shares to sell short is difficult given "actual" naked shorting enforcement is also contributing to the mania. Fundamentals have been improving lately with two straight quarters of positive operating cash flow. At least in the short term, the market finally believes VG can avoid bankruptcy. They are doing better in terms of managing marketing expenses, but the balance sheet and customer bleed are awful. I wouldn't be surprised to see the stock back below $1 next week.

5 (More) Profitable Smallcaps Trading at a Fraction of Tangible Book Value

13-D fillings ( www.sec.gov/answers/sc... ) just showbeneficial ownership of the company's shares. Since these filings were made shortly after the debt announcement, it is unclear whether or not these are new holders on the open market or the beginning of senior debt owners converting into new shares. Either is possible. I tend to believe the latter because the filings include huge blocks of shares and there were only 4M shares traded on July 1st following the announcement. Here is a summary:

Company Shares

Goldman Sachs Asset Management 1,534,369
Hale Capital Partners 149,488
Highbridge Capital Management 1,325,136
Tennenbaum Capital Partners 1,325,135

5 (More) Profitable Smallcaps Trading at a Fraction of Tangible Book Value

GSIG has not filed formal financial statements since that announcement in October 2008. Their last statement says that the company's cash position has not been impacted by the revenue recognition issues - finance.yahoo.com/news... - but it's likely that cash pile has been impacted by the company's results since it's last report and is now significantly lower. We will see when they finally file formal financial statements. Revenue declines and high interest payments on their debt from the Excel acquisition ( www.gsig.com/investors... ) likely exacerbated losses. Recently, much of that debt was converted into equity - finance.yahoo.com/news... - at extremely high dilution to shareholders. The stock is still very speculative. Best.

10 Small Cap Stocks with Double-Digit Free-Cash-Flow Yields

Kris - I acknowledge that these are not ideas for momentum traders, but for deep value investors. However, valuation may signal a reversal of trend. All five of the stocks in my last piece (seekingalpha.com/artic...) had similar charts and all but one (GSIG, which I had labeled as by far the most speculative of the group) have since reversed trend and handily outperformed the Russell 2000.

Liquidity is indeed an issue, and I have tried to point that out. For individuals, liquidity should not necessarily prevent taking small positions at attractive prices. Institutions are a different story and that is why SmicroCaps provides analytics and other services to help gauge and minimize price impact. While pricing of thinly traded stocks may be manipulated in the short term, it is my belief that fundamentals will prevail and the risk/reward story is compelling provided that an investor is willing to tolerate short term volatility.

Thanks for your comment.

On Jul 02 01:22 AM Dr. Kris wrote:

> Hi! I like what you're trying to do but looking at the charts of
> those you've recommended, I have reservations.
>
> For one, the average daily volumes on all of your issues are under
> 200k shares, except for AWI which is around 350k. And five of your
> issues have average trading volumes under 75K shares (
> AMPH, UFPT, PCCC, MGIC, WPCS, FRD).
>
> The problem with small issues is that their stock prices can be easily
> manipulated.
>
> Just my opinion.
>
> Dr. Kris

Closing Update for Wednesday, July 1

It terms of GSIG, it wasn't just about restating revenue today. It was about yesterday's news after the close regarding restructuring of the company's debt:

biz.yahoo.com/prnews/0...

Basically, the debt load taken on for prior acquisitions is being reduced to $95M, but current equity holders will be diluted by an astonishing 80%. The price impact of this news was much more significant than the initial revenue restatement.

10 Small Cap Stocks with Double-Digit Free-Cash-Flow Yields

A brief update/clarification: the bulk of this piece was prepared earlier last week and does not include Friedman's quarterly results which were released after market close on Friday, June 26th - finance.yahoo.com/news... - and are weighing on the stock so far this morning.

U.S.'s sovereign credit rating remains "a solid AAA," Moody's says, but adds a couple caveats: 1) Its assumptions of "debt reversibility" prove to be overly optimistic. 2) A potential challenge to the dollar as the main reserve currency. More here.

Regardless of our country's massive debt burden, Moody's... like Hollywood, is an entity that thinks it's more powerful and relevant than the US Federal government. At least the folks on the west coast admit that what their business is based illusion and fantasy.

Hey Microsoft, Use Debt Sale for M&A

MSFT's problems have less to do with financing and more to do with operational focus and limits to growth. The company is not realizing synergies within business lines. In order to refocus on individual segment organic growth opportunities, Mr. Softy should consider an option that few rarely speak of - split the company up. Pile a bunch of cash into the online division and give it the firepower (and freedom) to take on Google. Give the mobile device division an opportunity to take risks and catch up to RIMM and AAPL. Let the entertainment division work alone to further solidify it's place in the console wars. With those growth engines returned to shareholders, the core business can take on the other 800-lb gorilla, ORCL, that is gaining market share across the board as well as smaller companies like CRM and RHT that have seen rapid growth.

Analysts spoke about this two years ago:

www.marketwatch.com/st...

While this may seem like a radical strategy, it should be on the table. If Ballmer doesn't even consider it, he is not evaluating all possible options to maximize shareholder value.

5 (More) Profitable Smallcaps Trading at a Fraction of Tangible Book Value

Actually, considering the interest payments on the debt issuance, GSIG would likely no longer meet the final criteria of the screener "LTM interest coverage ratio no lower than 15 (or zero debt)."


On Apr 13 11:32 AM Tom Shohfi wrote:

> You are certainly correct - thank you for pointing this out. More
> at:
>
> biz.yahoo.com/e/080821...
>
> As I had mentioned, this analysis is preliminary and GSIG is a very
> speculative holding. Assuming GSIG hasn't generated any new cash
> since June 2008, it would still have $60M in cash after the acquisition
> and would likely have a reduced tangible book given goodwill. The
> stock still meets the criteria of the screener.
>