Worth More Dead than Alive

 | Feb 08, 2012 | 2:30 PM EST
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The entire process of investing in stocks revolves around risk, which, as I define it, is the probability of a permanent loss of capital. But what if you could find stocks that were worth more dead than they were currently valued in the marketplace? In other words, if the company went bust or decided to liquidate, equity holders would stand a chance to more than what they invested.

This special area of investing calls for nuance. Using the price-to-book ratio as a measurement for liquidation value is like a walking through a minefield. Low P/B ratios are part of the approach, but one has to really look at the individual components of what makes up the equity value of the business in order to determine the true net asset value of a business.

Retailer Books-A-Million (BAMM) has a market cap of $37 million, total assets of $311 million and total liabilities of $204 million as of Oct. 29, 2011. Of that asset figure, $247 million are current assets, defined as assets that readily be converted to cash. In addition to having a net asset, or equity value of $107 million, BAMM has a net current asset value of $43 million, or 20% above the current market cap. In other words, if the company's long-term assets were written down to zero, the current assets would more than cover all the liabilities and leave more than the current market cap left over. But more than 90% of the company's current assets are inventory: books, magazines and the like. Anyone that visited a Border's when it was going out business last year knows that it was marking down its books by more than 70% to get rid of them. In the case of Books-A-Million, there is no worst-case scenario protection for equity holders. Of course, I'm giving no consideration to the value of business as a going concern, something that must always be done. In this case, I see no hope for a small-cap book retailer in the world of Amazon (AMZN) and Barnes & Noble (BKS).

MedCath (MDTH), on the other hand, looks intriguing. MedCath, with a market cap of $149 million, owns and operates two hospitals in California and Texas. Assets total $404 million against liabilities of $86 million, or tangible equity value of $310 million. About $235 million of that net asset value is current assets, of which $114 million is cash. PP&E is listed at $143 million. I would argue that the value of a cash-flow producing medical facility such as a hospital holds value pretty well in any environment. While MedCath is likely to succeed going forward, it appears there is good protection for equity holders. That protection could erode over time if management makes poor business decisions, but that is a risk all investors assume and must monitor accordingly.

A more interesting name is Endocyte (ECYT), a biotech company focused on developing treatments for cancer and other inflammatory diseases. The company's principal product has been evaluated in a randomized phase II clinical trial for the treatment of women with platinum-resistant ovarian cancer and it also completed a phase II single-arm clinical trial for advanced non-small-cell lung cancer. The company has a market cap of $128 million and more than $136 million in cash and short-term investments. Total liabilities are a little more than $18 million. As you might imagine, the company currently consumes cash and that will likely be the case during the phase II trial. Earlier this year, major shareholder Sanderling Ventures bought nearly 400,000 shares an the stock plunged 60% on disappointing phase 2 results. Endocyte is more like a lottery ticket with more than one way to hit the jackpot.

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