More-troublesome zombies

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.