A Growth Stock and a Cigar Butt

 | Sep 27, 2012 | 1:00 PM EDT
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Wednesday was a nice takeover day. There was a going-private announcement from American Greeting (AM), a stock I recently suggested to readers. This deal is a bit of a take-under and I would not be surprised to see a higher price before all is said and done, but the stock is up nicely in the last month. We also had a microcap safety-and-construction products company receive a going-private offer from management. Although the companies are in different industries, they have some things in common. Both these management-buyout companies had solid balance sheets, were profitable and traded well below book value.

I ran some screens to find other gems with similar characteristics. There is no guarantee these companies will be the subject of a takeover offer, but they seem to be safe and cheap with solid upside potential. I looked for companies trading below tangible book value with plenty of cash on the books and turning a profit over the past 12 months. Consistent with the screening results of late, there are not many but a couple of them are interesting.

U.K.-based data storage and security concern Xyratex (XRTX) makes the list of safe and cheap stocks. The company has seen its stock price continue to slide after cutting revenue forecasts for the second half. It also has problems with high-end computing products that have experienced technical and performance issues. The stock is down about 30% this year as the company struggles in the weak global economy.

The same logic can be applied to this stock as with Seagate (STX) when it fell to the single digits a couple of years ago. Xyratex is a big player in what is going to be a huge market. Purchases of data storage equipment and programs may be delayed, but eventually this market will explode. The growth of social networks, smart phones and cloud computing will fuel the need for data storage for decades. Government regulations around the world are requiring longer record retention for industries like finance and health care and that will drive demand for data storage. The company may have short-term difficulties, but its customer list includes pretty much all of the computing and storage players. It sells equipment to all the leading data storage manufacturers and it should grow along with exploding demand in the marketplace.

Meanwhile, the stock looks safe and cheap. The shares currently trade at just 70% of tangible book value. There's no long-term debt on the book and the company's cash is half the current capitalization. The current EV/EBITDA ratio is a miniscule 1.6. The stock is one of the cheapest when valued as a going concern as the shares trade at less than half my estimate of intrinsic value. As a bonus, the company pays a dividend and the shares yield more than 3% at the current quote around $9. The company may struggle for the next few quarters, but the shares are cheap enough to begin scaling into the stock.

RealNetworks (RNWK) is pretty much a cigar-butt stock with only one puff left in it. The company has about $8.11 in cash and the stock's previous close was $8.38. Management has not executed well and has lost share in most of its major markets. The company is still alive, though, and the sum of the parts is worth more than the current stock price. It is not a very good business, but since you are only paying for the cash on the books, it does not have to be. The best thing that could happen here would be to sell the patent portfolio and remaining operations and return the cash to shareholders. This stock is cheap enough to hold your nose and buy a few shares. Founder Robert Glaser is acting CEO until a new one can be found and a restructuring plan completed. As the owner of 38% of the shares, he has a great deal of incentive to correct the course of the company.

Finding safe and cheap stocks is becoming increasingly difficult, but these two seem to fit the bill.

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