Thursday, March 3, 2011

Belzberg: An Uncertain Payout

Value investors usually cringe when a company trading at a large discount to its assets announces an acquisition, as it usually means capital that would otherwise be distributed to shareholders is ending up elsewhere. True to form, last week Belzberg (BLZ) fell 19% in the trading day following an announcement that it was going to purchase Frontline Technologies for cash and stock. But looking deeper into the transaction suggests a strategy that actually unlocks for shareholders the little value that is left in Belzberg.

This is because the purchase transaction is rather small compared to how Belzberg plans to proceed with the rest of its assets. In the year following the transaction, Belzberg will issue a special dividend and distribute to current shareholders all of its working capital less:

1) $2.75 million
2) The costs associated with shutting down its US operations (offset by referral fees Belzberg will receive for sending clients to a new firm)
3) The $1 million purchase price for Frontline

With Belzberg's latest working capital balance sitting at $12 million, the payout as things currently stand (assuming #2 nets out to zero) would be 56 cents/share, versus the 40 cents/share at which shares closed in the day following the announcement. This would seem to suggest a value opportunity; however, there are two quirks to the situation that add significant uncertainty to the size of the dividend.

First, Belzberg has a proven track record of consistently losing money throughout the last few years. While the $12 million in working capital referenced above is as of the company's latest snapshot, five months have elapsed since this company's last financials. Furthermore, the dividend may not be paid out for another year. This means shareholders should allow for about 1.5 years (adding up the past and the future) of further losses, which could be anywhere from a few cents to tens of cents per share, based on the company's recent performance.

Another hidden factor with the potential to materially affect the size of the distribution is the fact that Belzberg will have acquired the working capital of Frontline at the time the distribution calculation takes place. But Frontline is a private company, and so Belzberg shareholders don't have details as to what amount is included there. It is possible that Frontline's working capital is approximately $2.75 million, which is why #1 is part of the equation above; but without any disclosure on the matter from Belzberg, shareholders are kind of in the dark. We do know that Frontline has revenue of $4 million, so the company probably requires a decent working capital amount, which could swing the distribution tens of cents per share once again.

The fact that there's a distribution of Belzberg's assets is good news for shareholders. Unfortunately, based on the information provided, the range of possible payouts is quite wide. Shareholders who buy in at the current price could end up with excellent returns; but on the other hand, there is also the possibility that they will lose. Shareholders who prioritize safety of capital may wish to take this opportunity to exit this value opportunity and deploy the cash towards an opportunity with a better risk/reward ratio.

Disclosure: None

1 comment:

Armen said...

I don't cringe when an undervalued company makes an acquisition given they don't use stock and they don't overpay. For example, see Audiovox's recent acquisition of Klipsch. They got a great deal and didn't use stock, and I'm sure shareholders will eventually benefit.

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