10/25/2011 11:45 PM ET|
Dare to invest in the walking dead?
Consider these market zombies, companies that have basically been written off and now trade for less than the cash they have on hand. Yet some, like Hawaiian Airlines and Heelys, may have life left.
Take care. With Halloween just days away, zombies may be lurking near your front yard.
But unlike the once-a-year visit the walking dead pay to most neighborhoods, the stock market is home to plenty of zombies year round.
Market zombies are companies whose stock market value sits spookily below the value of the cash on their books. In other words, investors have decided the businesses attached to that cash have no value at all -- that they're as good as dead. A market Dr. Frankenstein -- say, a corporate raider or an acquirer -- might shut them down and make money from their demise.
Halloween is a good time to take a look at these zombies, because it's a time when we all love scary stuff. While some market zombies should simply be put out of their misery, others -- say, General Motors (GM) or Hawaiian Airlines -- could turn out to be treats for investors.
Market zombies come to life
Not unlike TV's "The Walking Dead" or the movie creatures that inspire that hit AMC show, market zombies roam the Street trying to attract human investors. And their cash looks tempting. The temptation is to purchase a stock trading at or below cash value to "get a business for free."
The risks are known to every movie star who's had to run from a shuffling monstrosity. A lot of market zombies are simply bad businesses with such consistently poor track records that they should have their heads chopped off and get shut down before they hurt someone.
But this is a trick-or-treat zone of the stock market, and zombies can turn out to be treats. For one thing, zombies make attractive buyout targets, which can make their stock prices rise -- a good reason to get in early.
In the classic scenario, activist investors target these companies as "better off dead than alive." Such investors purchase big positions, then close down the companies for the cash. "That's an old value investing concept from the 1930s," says investing icon David Dreman of Dreman Value Management. "Back then, there were a lot of liquidations." Investors would often get more for the assets than expected.
That scenario is less common these days. But management can also buy breathing room with a zombie's cash and use the time to fix the business. Investors benefit in the long run.
With that in mind, let's take a look at some market zombies lumbering around right now -- some that might be good buys, and a few to run away from.
Hawaiian Airlines: Zombie in the sun
Hawaiian Holdings (HA), which runs Hawaiian Airlines, is a classic market zombie. The company has about $6.35 a share in cash, according to John Buckingham of Al Frank Asset Management, who helped me find zombies for this column. Its stock goes for about $5.30 a share. (The company also has a lot of debt, but that's directly offset by the value of 24 aircraft the company owns.)
This means investors are assigning zero value to the airline business. To me, this makes no sense, and not just because zombies hate sunshine. Hawaiian Airlines' business is thriving, and you can make a good case that the future looks even better.
"We are a profitable business. We just reported pretty good results for third quarter," says finance chief Peter Ingram. The company recently posted a 29.5% increase in operating revenue, a 55% increase in operating income and earnings per share of 50 cents. The airline has produced solid operating cash flow of $160 million in the past 12 months. And analysts project decent earnings growth in 2012 over 2011.
The company has been adding international routes to supplement its traditional business of operating flights in the Hawaiian islands and to the West Coast of the U.S. This includes new service to Tokyo and Osaka, Japan, and Seoul, South Korea. The airline is also adding four aircraft next year.
So why do investors write Hawaiian off as a zombie? Probably because of concerns that the U.S. is slipping into another recession. But that scare story has been circulating for months, and it doesn't match the economic numbers. Likewise, Hawaiian sees no signs of this doomsday scenario playing out. "At this point we haven't seen the concerns of economic weakness reflected to any extent in our forward bookings," says Ingram. "We have seen a good level of demand."
Heelys: A rolling zombie
Heelys is a zombie on wheels -- those wheeled shoes which were all the rage several years ago. Back then, Heelys raised lots of cash by going public just as it was hitting its peak.
Demand tapered off as excessive inventory flooded stores. Sales slumped, and so did the company's stock. It's fallen to $2 from $40, where it traded shortly after its late 2006 initial public offering.
Down here, it trades below cash per share of $2.22, which makes Heelys a rolling zombie. Buy the stock now, and you get the business for free. Sure, the company continues to report losses and burn up cash. But it's also showing signs of life. It reported sales gains in the U.S. during the second quarter, a positive, even if overall sales were down, in part because of the hit to Japanese sales from the tsunami.
Sales of new models like Wave, Straight Up and Double Threat have been strong. And by the holiday season, Heelys should be in at least 2,100 stores, a 40% increase over last year. Eric Marshall, co-portfolio manager of the Hodges Small Cap Fund (HDPSX), thinks this holiday season looks more promising in part because Heelys has introduced a low-cost model to be sold through Kmart, part of Sears (SHLD). Marshall might have a knack for spotting good zombies; his small-cap fund, which owns the stock, has beaten funds in its category by 9.8 percentage points over the past three years.
GM: Not a zombie just yet
At first glance, General Motors looks like a zombie in the making. But if you look closely, it's not so much.
It has about has $21 a share in cash, or $32.7 billion, and its stock recently traded for only slightly more at $25, which makes it seem like you're getting its revamped car business for almost nothing.
But GM provides a good lesson on how you have to do your homework when hunting zombies. Drilling down reveals $12 billion in debt and about $22 billion in unfunded pension liabilities, according to Chris Quigley of Al Frank Asset Management.
So that cash is pretty much spoken for. GM still may still be a buy, though. Its debt and the unfunded pension liabilities aren't due for a while, so the $32.7 billion in cash provides some nice safety.
Meanwhile, GM has rolled out cars like the Buick LaCrosse and Chevrolet Cruze that are the "best quality and design in decades," says David Whiston of Morningstar, which has a five-star rating on GM, Morningstar's highest rating. And the company has shifted a lot of retiree health care costs to the employee labor union. "We expect GM to report excellent earnings growth as vehicle demand comes back during the next few years," says Whiston.
3 zombies in hiding
There's another way that investors can make money off hunting zombies. Many companies have unappreciated creatures lurking inside. These are divisions that aren't being fairly valued by the market because they're part of a conglomeration of disparate businesses. They're hidden zombies.
When spun off to shareholders, these divisions often shed their zombie status and take on new value, delivering profits to shareholders in the process. Todd Lowenstein, portfolio manager of the HighMark Value Momentum (HMVMX) fund, cites three examples of companies he owns because what lurks inside.
Early next year, he believes, the energy company Williams (WMB), will spin off its exploration and production business to shareholders while keeping its pipeline and energy infrastructure business. He believes the maneuver will help investors properly value both businesses. This will ultimately help current Williams shareholders realize $40 per share in value, a 33% gain over the recent Williams stock price of around $30.
Likewise, Lowenstein thinks auto parts supplier Visteon (VC) has a zombie of sorts lurking inside, in a Chinese joint venture he thinks will get spun out at some point as part of a consolidation around Visteon's Korean business. The move could add $10 to $20 per share in value for current investors, he says. And he thinks Tyco (TYC), investors could see gains of $10 to $30 a share as the company sells off its security and flow control divisions. The latter sells things like valves and pipes.
Many seasoned value investors, folks who specialize in finding hidden worth, express doubts about investing in zombies. "I have mixed feelings about the net cash approach," says George Putnam of The Turnaround Letter, which has a good track record in selecting troubled companies that pay off as investments. "Often, the company is not able to use the cash to develop a profitable business, and as a result the stock goes nowhere."
Indeed, I'd personally be cautious about the following two zombies because even though they trade below cash value, sales and earnings trends look terrible or, at best, weak.
UTStarcom (UTSI), which sells Internet TV and broadband technology, trades for $1.40 a share even though it has $1.88 per share in cash. But sales shrank in the trailing 12 months, compared with the 12 before, and the company reports a significant cash bleed. In fairness to the company, it is beginning to report modest profits after two years of big losses, and sales advanced 24% in the most recent quarter. The company projects sales strength will continue, which means this zombie may have life left.
Likewise, I'd be cautious with the Chinese online game developer The9 (NCTY), which reports $8.28 per share in cash, while its stock trades much lower, at about $5. Revenue contracted 94% in the past 12 months to $16 million, compared with the prior 12 months. The company is also bleeding cash. It lost $2.33 a share in 2009 and $3.02 a share in 2010, and it is expected continue to lose money in the next two years.
The company declined to respond to questions for this article, but it is in the process of launching new game titles, such as Shen Xian Zhuan and FireFall. And it has said it believes its Web-based, mobile and social games have "high growth" potential. "We believe The9 is now entering into a new phase of development and the coming year will be a fruitful one despite many challenges we may have," CEO Jun Zhu said in a mid-August press release announcing quarterly results.
Value pros point out another zombie hazard. Even if cash exceeds market cap significantly, says Buckingham, the difference can vanish quickly as the business winds down because of costs like long-term contracts and leases.
Still, zombies being zombies, they have been known to come through with nice surprises that mean handsome payoffs for investors, even when they aren't shut down. For much of the summer, shares of BigBand Networks, which provides video networking services, drifted eerily lower. The stock traded as low as $1.25 per share, despite cash levels of $1.81 a share. But October brought a nice treat for anyone who bought this zombie.
On Oct. 11, Arris Group (ARRS), which provides broadband technology, announced plans to buy BigBand Networks for $2.24 per share in cash -- a nice profit if you bought during the summer close to the lows.
You see, you can love a zombie after all. Isn't that what Halloween is all about?
At the time of publication, Michael Brush did not own or control shares of any company or fund mentioned in this column.
Michael Brush is the editor of Brush Up on Stocks, an investment newsletter. Click here to find Brush's most recent articles and blog posts.
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