Not All Net-Nets Are Good Values

 | Mar 13, 2012 | 1:30 PM EDT
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When the market is heating up, no investor wants to be the one caught holding the bag. Each day the market rises, the equity risk premium also rises. Yet thanks to an artificially created zero-interest-rate environment, unnatural forces continue to steer capital away from no-yield investments to equities. Against this backdrop remains one of the most appealing and most often misunderstood asset classes: net-net stocks.

If a company's net current asset value, defined as current assets minus all liabilities, exceeds the current market cap of the business, then there is a sound argument to be made that generally speaking, the company offers the greatest degree of protection from loss of capital. This general assumption becomes more relevant on a case-by-case basis.

Cash is a safer current asset than inventory. A cash-light, inventory-heavy business may be a net-net stock one day and a bankrupt company the next month, depending on the make-up of the inventory. Books-A-Million (BAMM) meets the definition of a net-net. The company has a market cap of $40 million, current assets of $248 million and total liabilities of $204 million. Yet the entire current-asset figure, $233 million, is inventory. It's an easy pass. 

Yet Maxygen (MAXY), a bio-pharmaceutical company focusing on treating disorders caused by chemotherapy and radiation, is an example of a solid net-net stock. The company has a market cap of $154 million. As of Dec. 31, 2011, Maxygen had $160 million in cash on the balance against $2 million in total liabilities. Back in May 2011, Maxygen sold a subsidiary for $72 million in cash. That sale was part of the company's multi-year plan to boost shareholder value by monetizing its various assets.

The company is now focusing on its singular product, MAXY-G34. Because of the asset sales, the company's cash burn rate is minimal at this point. Basically, investors are getting a free option on any further upside from MAXY-G34. The market is basically ascribing no value to any of company's intellectual property, despite Maxygen's rather good track record of monetizing or commercializing these assets. In the meantime, the company's cash balance creates a huge degree of safety.

Steel Excel (SXCL) is another quality net-net at this juncture. The company's market cap of $306 million compares with $355 million in cash and marketable securities against total liabilities of $15 million. Steel Excel was formerly known as ADPT, but after a recent capital restructuring it changed its name to Steel Excel. The company's business is to identify and acquire other businesses in order to maximize the value of existing net operating losses.

Steel Excel is 40% owned by Steel Partners, a global holding company that owns and operates businesses in a variety of industries. With such a significant shareholder in the fold along with current valuation that is almost 20% less than net current asset value, Steel Excel meets the definition of a high-quality net-net. The company has recently made some minor acquisitions related to sports and oil-well services. If the company can execute on its plans, there is no reason that shares should not immediately be reappraised to at least net current asset value.

Not all net-net stocks are created equal. A low-quality net-net is often a very speculative bet rather than a value play. But quality net-nets are often very attractive ways to pick up 10%-20% returns, sometimes more, by simply waiting and letting the market take notice.

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