By 5i Research
“What makes small-capitalization stocks so interesting to many is that you can often find underfollowed and lesser-known companies showing exciting prospects yet operating largely unnoticed by the markets. This type of dislocation can become even more pronounced in volatile markets, such as what we are seeing today. Our team at 5i Research have identified three such companies, two of which pay a dividend. Often, when investors begin to get spooked, they simply sell anything that looks higher risk, regardless of the potential and sometimes regardless of the balance sheet. So we wanted to highlight two names that may have been thrown out with the bathwater in the recent market:
C-COM Satellite Systems Inc. (TSXV: CMI):
This is a small-cap and high-risk name through and through, so please do not rush into this one with eyes closed. It trades thinly and can see large moves any given day on no news. What is interesting about C-Com, however, is that it currently pays a 4.7% dividend and has $14.43 million in cash ($20.23 million if we include receivables and inventory) while holding a market cap of only $38.41 million. Let’s break down what this cash could mean to investors:
- Straight cash amounts to 37.6% of the company value.
- The dividend could be paid for roughly eight years at the current rate and share count. This amounts to $0.40 in nominal value.
- While nice, a good dividend rarely makes up for large capital losses such as what C-Com has seen over the last year
- Per the below table, if CMI were to use the idle cash for a buyback, the company could create significant value:
| Value in Millions | ||||
| Cash as of May-2015 |
$14.43 |
|||
| Shares outstanding |
36.15 |
|||
| Share price ($) |
$1.05 |
|||
| TTM income |
$2.26 |
|||
| Current TTM P/E |
16.80 |
|||
| Proportion of cash used for buyback: |
50% |
65% |
75% |
80% |
| Cash used in dollars |
$7.22 |
$9.38 |
$10.82 |
$11.54 |
| Shares repurchased at above noted price |
6,871,428.57 |
8,932,857.14 |
10,307,142.86 |
10,994,285.71 |
| % of outstanding shares repurchased |
19% |
25% |
29% |
30% |
| TTM P/E after buyback |
13.60 |
12.65 |
12.01 |
11.69 |
As can be seen, putting this cash to work can create some interesting value for C-Com and this treasure chest of cash is the main reason we have been positive on the stock in the past. Unfortunately, the company just has not taken action with the cash balance and continues to build up the reserve. We typically prefer to err on the side of conservatism at 5i Research but there does come a point where too much cash simply drags down investor returns and hurts, opposed to helping,shareholders. Not to mention, CMI is a cash-flow positive company with no debt on the balance sheet, so it is not there to protect against any leverage!
WiLAN (TSX: WIN):
Wi-Lan is particularly interesting to us. While there are risks, we would hardly put it in the same category as C-Com due to much better liquidity and a marketcap of $305 million. The dividend offers an 8.3% yield at this time while the forward valuation is only four to five times earnings. Similar to C-Com, this is a company we would hardly classify as distressed. WIN offers positive cash flows that cover the dividend, little leverage and a cash balance of $114.1 million, or 37% of the market-cap. While a focused buyback is likely a little more risky for a company such as WIN due to heavy investment into acquiring patents and a bit of debt on the balance sheet, this cash offers quite a bit of a cushion. The cash balance would support the dividend for just over five years. So why the red flags? Why does WIN trade at very low multiples and offer such a high yield?
We think it is due to two factors. The first is simply that the company has disappointed shareholders time and again and most investors have decided to throw in the towel and look elsewhere. The other is that the company has had issues with providing guidance that was anywhere near accurate. Because of this, WIN has stopped issuing guidance and does not provide details on any licensing agreements that are signed. This creates a bit of a black hole and adds to uncertainty.
Wi-Lan could very well be a value investor’s dream, with a low valuation, financial flexibility, dividends and profitable operations. Even if the dividend were at risk, the current valuation and cash balance should offer significant downside protection.Now that expectations seem to be so low for WIN, there is also potential for some surprises to the upside and recent deal momentum has looked positive. Wi-Lan is not for the faint of heart but in the current market volatility, it is likely one to at least keep on your Watchlist. We hold WIN in the 5i Research model income portfolio as a means for some higher risk, outsized dividends and feel it can be a good, higher risk complement to an otherwise more stable portfolio.
Knight Therapeutics Inc. (TSX: GUD):
While we have talked about Knight previously on SmallCapPower and cover it at 5i Research, it is a company that is worth mentioning in the context of high cash balances. GUD holds a marketcap of nearly $744 million and a cash balance of $443.9 million as of the most recent quarter. That equates to 59% of the company market capitalization, or ~$4.77 per share in cash. Knight will use the cash to acquire interesting drugs and it is largely a play on a strong management team (former team at Paladin Labs), so there is a bit of a leap of faith that management can effectively deploy the cash. What is really interesting at this time, in our view, is the relative stability that GUD has offered in a rather volatile market thanks to this cash balance. GUD is a volatile and higher risk stock on all accounts but in the context of the healthcare sector, which is full of high-risk names, the cash balance has been acting a bit like a buoy for investors. The recent healthcare selloff on September 25th saw the TSX healthcare sector drop more than 5% while GUD only fell 2%. This is not the type of price action one would typically expect from a smaller capitalization healthcare company. The TSX is down over 10% over the last three months, while GUD is up 2.6%. We would attribute much of this performance to the cash balance, which has likely created some downside protection for the company.
None of these companies are appropriate for every investor but all three hold qualities that are interesting with the common denominator being a large amount of cash that offers a greater degree of financial flexibility. While all companies need to be able to generate returns with the cash, we like the options at their disposal.
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*Returns as of August 31, 2015
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See more Peter Hodson interviews:
http://www.smallcappower.com/posts/article-amaya-gaming-group-11-7-2014
