Emerson Radio: A Value Trap

| About: Emerson Radio (MSN)

Summary

The current salvage value per share is about $1.48; however, tax issues could decrease the value to $0.75 per share, removing any margin of safety in the valuation.

Emerson Radio's revenue is down 6.5% for the six-month period of fiscal 2015, whilst its net income plummeted by 60%.

Uncertainty on the future of the controlling shareholder could add further pressure on the share price.

Description:

Emerson Radio Corp. (NYSEMKT:MSN) is a US consumer electronics distributor with a focus on low-to-moderately priced products. Emerson is involved in the sale of a wide range of products, from audio accessories to microwave ovens and wine coolers. The company distributes its products via retailers and also through licensing agreements.

MSN has a market cap of approximately $27.5m and a share price of $1.01 (as of 12th December 2014).

MSN Chart

MSN data by YCharts

Recent performance:

Revenues for the six-month period of fiscal 2015 are down 6.5% to $40.2m, compared to the previous period at $43m. This is attributable to a 7.5% decrease in net product sales to $37.7m, whilst licensing revenues increased by $0.2m during the period. The decrease in sales was driven by a 7.4% drop in housewares product sales to $36.1m for the six-month period of fiscal 2015. Audio products sales were down 8.2% to $1.6m during that same period.

The company's sales were highly concentrated among the two largest customers, representing about 89% of gross product sales.

The net income in the six-month period of fiscal 2015 has plummeted by 60% to $0.7m, compared to the same period in fiscal 2014 at $1.75m. Margins are low, with cost of sales amounting to 90.7% of net sales during the six-month period of fiscal 2015.

On the bright side, licensing revenues increased by 10.4% during the period. Licensing revenues were predominantly driven by the largest license agreement with Funai Corporation, Inc., accounting for 75% of licensing revenues during the period. The agreement was renegotiated at the end of 2013, and Emerson Radio will receive a minimum annual royalty payment of $3.75m each calendar year until the expiration term in 2018.

Balance Sheet:

One of the main elements in Emerson's balance sheet is the cash and cash equivalents, totaling approximately $26.8m as at the end of September 2014. This line item has decreased compared to the balance as at the end of September 2013, as the company distributed an extraordinary dividend to its shareholders. This is a positive sign, as it demonstrates the willingness of the management team to redistribute value to shareholders. On the other hand, this also indicates that opportunities for acquisition or future growth development were potentially scarce, and this could limit the growth prospects for the company.

Emerson also holds short-term investments amounting to $15m as at the end of September 2014. In addition to this, the company recorded $7.08m receivables.

Liabilities are quite light, and consist mainly of account payables to the tune of $3.95m as at the end of September.

Summing the main balance sheet elements above, I see a net asset value as at the end of September 2014 of approximately $40.7m ($26.8m cash and cash equivalents, $15m short-term investments, $7.08m receivables, -$4.4m liabilities, -$3.7m preferred shares).

Please note that the net assets above exclude about $12.6m of other assets on the balance sheet, which are mainly inventory and prepaid expenses. In the event of a liquidation, I believe that inventory would get a substantial haircut, and I choose to discard it from the bankruptcy value.

The $40.7m net assets compare favorably to the current market capitalization of $27.5m, with a theoretical salvage value approximately equal to $1.48 per share - this represents a 46.5% upside potential, based on the 12th December 2014 share price of $1.01.

However, several elements could materially reduce the value of the balance sheet:

  • Emerson has tax issues concerning overseas income, and has received correspondence from the IRS challenging the position of the company on those matters (referred to as NOPA 1 and NOPA 2 in the financial statement).

The company estimated the maximum liable payment for NOPA 1 to be $14.9m. With respect to NOPA 2, Emerson has estimated that it could be liable for a payment of $1.3m.

The company is disputing the proposed adjustment with the IRS regarding NOPA 1, and assessed the probability of being unsuccessful in this dispute as low. Regarding NOPA 2, the company agrees in principle with the IRS' position, however it disputes the adjustment.

Even if NOPA 1 is estimated as a low probability item, if both tax issues were to become liabilities, this would have a material effect on the balance sheet by adding an estimated $16.2m liability.

  • Dividend related issues with respect to S&T.

The company is defending its position with the IRS, which challenges the tax eligibility of dividend payments to S&T, a subsidiary of the Grande Holdings Ltd., the controlling shareholder in Emerson Radio. This explains the $0.5m restricted cash recorded on the balance sheet, which is collateral pledged by S&T with respect to this issue. The company has estimated that it may be liable to pay $4.7m if it can't agree with the IRS that the tax treatment related to the dividend was correct. Given the $0.5m pledged collateral, this would still leave Emerson with a potential $4.2m liability. This liability could prove difficult to recover, given that The Grande Holdings Ltd, parent of S&T, is currently in liquidation.

Overall, those tax issues could add an estimated $20.4m drain on the balance sheet, decreasing the net asset value calculated above from $40.7m to $20.3m, or $0.75 per share, 26% below the current share price of $1.01.

Admittedly, those liabilities may not all materialize if the company is successful in defending its case. However, I interpret those as non-negligible risks, and given the weakness in sales and income results, I believe this to be a deterrent in going long on this stock.

As mentioned above, the controlling shareholder (approximately 56.2%) is currently in liquidation.

According to Emerson Radio's financial statement, discussions are ongoing regarding a potential restructure of The Grande Holdings Ltd. Nonetheless, a potential outcome could be that the controlling shareholder would liquidate its controlling interest in the company. Depending on the exit path, this could adversely impact the current share price. On a positive note, this could bring a new controlling shareholder that may enhance the company's outlook.

Conclusion:

Despite a strong balance sheet representing approximately $1.48 per share, I believe that there are some non-negligible risks regarding tax issues. If all of those were to come into effect, the balance sheet value could drop to $0.75 per share, thus removing any safety margin for a value investment case.

The income potential remains somewhat limited, in my opinion, given the low margin and the decrease in revenues.

Given the points above, I would refrain from investing in this company for the time being.

On the upside, however, licensing revenue has increased and could lead to some income growth at higher margins. Additionally, the prospect of a new controlling shareholder may bring a fresh turnaround.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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