Two Stocks With Private-Equity Appeal

 | Jun 19, 2013 | 1:00 PM EDT  | Comments
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This morning, I felt like a little kid waiting for the fireworks to start. All anyone could concentrate on is the impending Federal Reserve release and what might happen. I have resisted the urge to get sucked into the prediction game and have just kept my head down and focused on selecting individual securities.

For some traders, today could be the end-all and be-all of existence, but since I have a very long time frame, it is just another bump along the road to long-term profit. I guarantee you that private-equity managers are not feverishly adjusting their holdings this morning in anticipation of a Fed move. They are more concerned about the value of their companies growing over the next several years. They may adjust their business plan to deal with the aftermath of a decision that leads to rising rates, but they won't give up on a valuable business because of what the Fed does.

I often compare asset-based value investing to private-equity investing. It is the process of discovering undervalued assets and holding them until either the value is recognized by the market or the resources are converted to cash. Over the years, I have even developed a screen for companies that might be attractive to a private-equity-type buyer. The screen looks for companies that have very low enterprise-value-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratios and room to lever up the balance sheet if necessary. I don't run this screen as often as I should, since my main focus is on assets, but I did so this morning to see if I could uncover any interesting long-term investing candidates.

One company that makes the grade is Argan (AGX), a holding company that provides construction and consulting services to the power and telecommunication industries. Its Gemma Power subsidiary designs and builds power plants of both conventional and renewable type. Its Southern Maryland Cable unit provides wiring and telecom construction services to a range of industries, including the federal government. There is nothing terribly fancy about Argan, but it generates a ton of cash flow every year, and it's way off the Wall Street radar screen for the most part.

Insiders and beneficial owners own about a third of the company and would seem to have a vested interest in a higher share price. Both divisions of the company should see a huge pickup in business and profits as the economy begins to grow.

Argan's valuation is compelling from a private-equity viewpoint. The company has a market cap of $243 million, no debt and $169 million in cash. Operating cash flow last year was in excess of $31 million. Trailing 12-month EBITDA is $40 million, according to Capital IQ, and the enterprise-value-to-EBITDA ratio is a rock-bottom 1.49. Earnings have shown solid growth for the past few years, even as many other construction-related companies floundered. This company is not a typical Melvin asset bargain, but the cash and cash-flow situation is screaming for an activist or private-equity investor to snap up the shares and unlock the value in Argan.

I am intrigued that magicJack (CALL) made the list. The Israeli-based voice-over-Internet phone provider trades with an EV/EBITDA ratio of just 4.1. The company is best known to most of us for its seemingly endless commercials, but it is selling a bunch of devices. Earnings have grown by about 20% a year for the past five years and should continue at near that pace for the foreseeable future. magicJack has no debt on the books and about $49 million cash and short-term investments. EBITDA was a little over $56 million last year, and the total market cap is just $285 million.

Short-sellers hate this stock for some reason, and more than third of the float is sold short. This company would be a perfect fit for a private-equity portfolio or as part of a larger telecom operation. Any hint of takeover interest would cause an enormous short squeeze that would send the stock rocketing higher very quickly.

Getting caught up in the short-term news, noises and gyration of the markets has been more difficult than ever this week. I have heard this described as the most important Fed meeting ever and a potentially world-changing event. I really doubt that either is the case, and I will continue to search for companies that I can own for long time and earn profits in multiples, not percentages.

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