A Small-Cap With an Activist Spark

 | Apr 29, 2013 | 1:00 PM EDT
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One of my favorite places to screen for stock ideas is the 13D filings snapshot found every week in Barron's. This past week, I came across an activist opportunity that was quite intriguing because of the way the activist has presented its case.

The company is FairPoint Communications (FRP), a regional provider of telephone and Internet service in New England. The current share price is $8.10, for a market cap of $213 million. Maglan Capital owns 9% of FairPoint. It has recommended to the board that FairPoint initiate the "immediate commencement" of a $1.50 annual dividend, a review of the sale process for FairPoint's telecom division and a review of the company's cost-reduction strategy.

If you are opportunistic like me, what jumps off the page is a $1.50 dividend possibility on an $8.10 stock, nearly a 20% yield. I don't know much about Maglan Capital, but apparently it is a firm that won't hesitate to go active but prefers to work with management privately. Maglan is primarily a long-side investor that has a preference for "companies that are deeply discounted to its peers with growing revenue and cash flows."

FairPoint emerged from bankruptcy in 2011 with a stock price of $24. That's very intriguing, because FairPoint's balance sheet shows long-term debt of $948 million. Net equity is a deficit of $317 million. Yet Maglan was quick to pick up 9% of the equity. The cash-flow statement may reveal why.

In the past three years, cash flow from operations was $190 million, $90 million and $193 million respectively, for a company that has a $213 million market cap. Annual interest expense has dropped from $140 million to $67 million over that same period. Since 26 million shares are outstanding, a $1.50-per-share annual dividend would cost about $40 million. Capital expenditures, which have averaged about $170 million per year, have been consuming cash flow.

You can see why this is a very intriguing idea and one worth looking into. The company has very lucrative and stable cash flows -- almost equivalent to the market cap and 5x enterprise value. I haven't looked closer at the debt profile, but since the company just emerged from bankruptcy, odds are that the debt covenants are quite good.

Maglan has been involved with FairPoint since before FairPoint emerged from bankruptcy. So Maglan has worked closely with management, and the relationship doesn't appear to be sour. Maglan appears ready do whatever is necessary to see FairPoint reward shareholders

In sum, you have an $8 stock that is generating around $8 per year in operating cash flow and paying about $3 per share in debt repayments. You do the math.

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