Selected Key Statistics: • Holding company unrestricted cash: $54 million • Total cash and investments (including restricted), net of debt: $65 million • 2007 EBITDA before unusual items: $24 million • Current EBITDA guidance: $21 million • Expected 2008 cap ex: $4 million • Annual revenue: $380 million • Net Operating Loss carryforwards: $309 million
Equity market value: $29 million
What’s wrong with this picture? Usually when I find companies trading at a meaningful discount to net cash, they’re also burning cash and have completely screwed up business models. EDCI (trading temporarily as EDCID, due to a reverse split) will never be confused with Microsoft, but it mostly seems to be doing the right things, should build additional cash reserves over the second half of this year, and has a solid shareholder base that is hopefully providing productive guidance regarding the company’s future.
At the same time, I’ve been meaning to write up this idea for months, and the stock just keeps getting cheaper. So, either VIC readers have a chance to buy a tremendous bargain, or the sellers are much more prescient than me.
No doubt, there’s plenty of hair on this beast. Stocks don’t go from $25 to $4 in 18 months without some good reason. EDCI was formerly a paging company called Glenayre Technologies. The paging business was sold in 2006 so that EDCI could focus on the CD and DVD manufacturing and distribution business it acquired from Universal Music (Vivendi) in 2005. The new business has underperformed, and industry-wide trends have been materially worse than expected. However, EDCI has a strong industry presence, particularly in Europe, and the valuation of this company seems to be explained only by the high level of investor disgust, tax-loss selling, and a massive exodus from microcap value stocks.
As a point of comparison, EDCI’s closest comp, Cinram International Income Fund (CRW-UN), has also struggled with the industry conditions and its stock has experienced a similar decline. The biggest hit occurred in November when the company suspended distributions. Nonetheless, Cinram still has an enterprise value of about $800 million, equal to about 40% of trailing revenues and nearly four times EBITDA. On an equivalent basis, EDCI might be valued at $20-30 per share.
An intriguing feature of EDCI is the ownership concentration of value-oriented and activist shareholders. Chapman Capital is the most active, as well as the largest shareholder. After agitating for more than a year, Bob Chapman joined EDCI’s board in November 2007, at the same time that the CEO stepped down. Chapman Capital owns 13% of EDCI, a position that was acquired at an average cost of $22 per share. Bob Chapman personally acquired an additional 25,000 shares last December at $6.10 per share.
At June 30, three other value-oriented funds – the State of Wisconsin Investment Board, Schooner Capital, and Roumell Asset Management – owned 18% of EDCI’s stock, aggregating 31% with Chapman’s position. With management controlling only about 1% of the outstanding shares, I think it’s safe to say that the value funds are in the driver’s seat. Third Point has been another prominent player here, though they have reduced their holdings to 2%.
I won’t bore you with details that can easily be obtained via the SEC filings and press releases. However, following are some additional specifics that may help investors get a handle on this situation.
History: EDCI has been an “NOL play” for many years. The company acquired the Glenayre paging business in 1992 to utilize NOLs that had been built up by previous operations. This strategy was spectacularly successful for several years (check a long term stock chart), until the paging business began to experience challenges and ultimately withered in the face of new technologies. The company attempted to take a second bite of the apple in 2005 when, in conjunction with former CEO James Caparro, Glenayre bought the CD and DVD manufacturing and distribution business of Universal Music.
Current Business Operations: After selling the remainder of the paging business, EDCI became a pure play manufacturer and distributor of CDs and DVDs. The core of EDCI’s business is a 10-year contract to be the exclusive manufacturer and distributor for Universal’s operations in the U.S. and central Europe. Universal currently accounts for about 76% of EDCI’s revenues. In making the acquisition, EDCI’s biggest mistake was believing that this business was experiencing a gradual decline in unit volume of 3-5% per year. In reality, the decline has been much more steep, particularly in the U.S., with total industry volumes declining more on the order of 10% per year. This decline has obviously created larger challenges for EDCI, and the company has missed its original expectations by wide margins. However, the business still has value and could generate $15 million of free cash flow this year.
Holding Company Structure: According to the company’s disclosures, all efforts have been made to maintain the acquired EDC subsidiary as a separate entity that does not create recourse liabilities for the holding company. Theoretically, this would allow EDCI to jettison the subsidiary if the business deteriorated to a point at which it might start draining the holding company’s resources. EDCI has not been successful at selling the subsidiary thus far, but a “worst case” scenario might be selling the subsidiary for a nominal amount to be rid of the assets and liabilities. Management insists that, absent the subsidiary, the holding company would have $54 million of cash, modest liabilities, and the NOLs that could be used in Round 3.
The Future: An investment in EDCI is premised on the expectation that the company can transition away from the current operating business and identify a successful acquisition candidate. Certainly, in today’s depressed market, the environment should be target-rich. In fact, if you have a suggestion from your own portfolio, don’t hesitate to give Jordan Copland or Matt Behrent a call. I’m of the belief that management – with appropriate participation from the board and, ultimately, oversight by the shareholders – is likely to succeed. Also that the current valuation discount is excessive. However, as always, each investor must do his own work and draw his own conclusions.
FWIW: Especially in today’s miserable stock market, it can never hurt to have some entertaining reading. As always, Bob Chapman’s 13Ds are worth a look. And the company's kiss-and-make-up press release of 11/6/07 is a classic.
1) Seasonally strong cash flows in the second half of 2008. 2) Progress with strategic dispositions and acquisitions.