Trolling for Bargains

The daily troll for bargain securities will always produce a few nibbles. Yet, it is not until after the important and sometimes tedious work of reeling in requisite information that one actually gets a glimpse of his catch.

One nibble this week was Seanergy Maritime Holdings Corp (SHIP). Having shown up on The Graham Investor’s NCAV screen, and having seen the substantial stake owned by Pine River Capital management, I took a closer look.

According to its recent prospectus, Seanergy is an “international company providing worldwide transportation of dry bulk commodities through our vessel-owning subsidiaries and Bulk Energy Transport (Holdings) Limited, or BET. Our existing fleet, including BET’s vessels, consists of one Handysize vessel, one Handymax vessel, two Supramax vessels, three Panamax vessels and four Capesize vessels. Our fleet carries a variety of dry bulk commodities, including coal, iron ore, and grains, as well as bauxite, phosphate, fertilizer and steel products.”

On many metrics—price to book, price to net current assets, and price to owners earnings—Seanergy looks stunningly cheap. With a “hard” book value (ex-goodwill) near $210 m, the current market price near $2.5 per share implies that the company is worth only $83m (given its 33.26m shares outstanding, as of 1/7/10).

Plausible reasons may be offered for this apparent discount: a) a short operating history (having only been public since 2008), b) a significant debt load (with $278m in long-term debt at 9/30/09), and c) general uncertainty about global shipping rates in the near term. While each is important, none would lead this analyst to immediately toss it back.

That is, until one notices their recent preliminary prospectus from Jan. 11, 2010, in which Seanergy proposes to sell up to $33.75m in common stock (and grant warrants to the underwriters), in order to “purchase a 2009-built Capesize vessel for $89.5m pursuant to the terms of a memorandum of agreement entered into on December 16, 2009 with an unrelated third party.”

Though the prospectus is only preliminary, and the pricing has not yet been set, if the offering priced at current levels (near $2.5 per share), nearly 13.5m shares would be sold, and the outstanding share count would increase by more than 40%.

In some respects, such behavior seems standard fare—acquisitions are made, cash is raised, and revenues are grown. Yet, for the investor, the only real interest is the effect of such decisions on (per-share) business value. And here the investor should be sorely disappointed.

Before the proposed offering, the shareholder is able to purchase a claim on $6.30 per share in hard assets ($210m / 33.26m shares outstanding) at a nearly 60% discount (given a market cap of $83m). After the offering, that same shareholder—after having seen $33.75m added in equity to buy a $89m asset, with the remainder financed with debt—would have a claim on $244m in hard assets. But, given the increase in shares outstanding (to near 47m), that claim is now against only $5.2 per share in hard assets.

In other words, the buyer of shares today is likely to see the per-share value of his claim on Seanergy’s assets fall by nearly 20%, if the proposed offering goes through near today’s market prices. Of course, were Seanergy’s price to fall further, the damage to existing shareholders could be greater.

Most simply, there is only one way that the offering makes sense for a rational capital allocator–that is, if the desired Capesize vessel can be purchased at a greater discount than the current discount of Seanergy’s shares. Relative to Seanergy’s “hard” book value, its shares are currently trading at a greater than 60% discount. Even if Seanergy’s current “hard” book value overstates the value of its current ships by 50%, today’s share price would still represent a significant (perhaps 20%) discount to this lower figure.

So does Seanergy’s new proposed purchase meet this test? Is the new Capesize available at a 20% discount to its fair value? Using the proxy’s most recent estimates, a new Capesize was selling for about $58m in September 2009 (p. 126). Paying $89m for such a vessel hardly looks like a 20% discount.

Better throw this fish back.

Disclosure: None

Three Cheers for Tucows?

In the past, we’ve profiled a handful of microcap companies (FNET, KSW, LIMC, RMCF), either with discernible competitive advantages, particularly rational management, or an imminent catalyst for unlocking shareholder value.

We continue in that vein today by profiling Tucows, Inc. (TCX), an ICANN-accredited internet domain registrar based in Toronto that manages email services and over nine million web domains. Through its subsidiary Butterscotch.com, it also owns one of the oldest and most popular software download sites on the Internet. At present, its principal shareholders include: Lacuna, LLC, which controls 17.7% of outstanding shares (as of 3/23/09), Diker GP LLC (13.7%), and Fertilemind Capital Fund I, LP (5.7%).

About two-thirds of Tucows’ revenue derives from its wholesale domain registration services, being the third largest ICANN-accredited registrar in the world and the largest publicly traded. And like other domain registry servicers (e.g., Network Solutions, GoDaddy), its business model is characterized by non-refundable, up-front payments, which generate predictable, positive operating cash flows. More specifically, Tucows receives payment for the annual registration fee prior to providing the full cost of the service, yet it is required to book those payments and costs incrementally. Looking at its balance sheet, one sees what—at first glance—may appear to be a highly-levered, capital-intensive business with nearly $97 million in assets and $75 million in liabilities. Yet, the bulk of these assets and liabilities pertain to prepaid fees and deferred revenues for their domain registry business. In truth then, Tucows is a cash-rich and largely unlevered business that fills its checking account faster than its earnings statement would indicate. In a way, its revenue resembles an insurance premium—non-refundable, and paid up-front—and enables Tucows to keep its cost of capital very low and perhaps even negative.

However, it is not only the balance sheet that masks Tucows’ virtues. In 2008, Tucows took initial steps to divest non-strategic assets and concentrate energies on its most profitable businesses. This process has complicated its cash flow statements and masked its significant free cash flow growth. For example, in 2006, depreciation and amortization charges of $3.9 million were less than capital expenditures ($4.6 million); in 2008, depreciation and amortization charges of $4.8 million far exceeded capex ($2.1 million). Because Tucows has significant amortization expenses—deriving from the intangible assets of previous acquisitions (i.e., customer relationships)—it has far more cash coming into the company today than its reported earnings reveal.

Lastly, Tucows has raised more cash in the last year by liquidating its $7.5 million equity stake in Afilias and a portion of its domain name portfolio. In their second quarter results (coming out in mid-August), Tucows will book a $2 million pre-tax gain on a portion of its Afilias stake; an additional $2 million pre-tax gain will also follow later this year.

Perhaps most interesting though is where all that cash is likely to go. In the last year, Tucows has used some cash to pay down its long term debt, repurchased 4.2 million shares (about 6% of those outstanding) in a “Dutch Auction” tender offer in March 2009, and repurchased an additional 1.1 million shares in a second “Dutch Auction” tender offer in July 2009. And to date, Tucows has ample room remaining in its $10 million stock repurchase program. Though the future capital allocation decisions are difficult to predict, the chains of habit are not easily tossed aside.

All told, Tucows strikes me as a relatively low margin business with low (and perhaps negative) capital costs that has deployed its retained earnings profitably for shareholders in recent years. Though GoDaddy is the dominant player in the sector, Tucows has added customers and concentrated its business lines. If Tucows continues to divest its non-strategic assets and contain its costs, I would not be surprised to see them earn more than $7 million this year ($4.5 million from operations and $2.5 from after-tax sale of investments). With a market cap of $29 million (as of 7/30/09), management and the Board should have an opportunity to buy back shares quite cheaply.

That is, unless enterprising investors find it first.

Disclosure: I, or persons whose accounts I manage, own shares of Tucows at the time of this writing.