Monthly Archives: February 2013

ALJJ completes tender offer, what to do next?

ALJ Regional Holdings announced the final results of its tender offer last Tuesday. With a proration factor of 90.8 percent almost all shares will be accepted by the company, and my merger arbitrage will be profitable no matter what I get for the remaining shares. I initiated my position at $0.75 and with the company buying 90.8% at $0.84/share I will receive effectively a bit more than $0.76/share. If the remaining part of the position could be sold at $0.75 (latest market price) the total return will be approximately 11 percent in a three month period. I’m happy with that. The big question is: should I actually sell my shares?


The company issued the following statement about it’s balance sheet and share count:

Following the completion of the tender offer, ALJ will have 27,446,598 shares of common stock issued and outstanding (29,646,598 on a fully diluted basis) and approximately $27.8 million in cash and receivables.

That’s $0.94 in cash per share on a fully diluted bases, so currently the company is trading at roughly a 20% discount to it’s cash value. That’s not what I would call a huge bargain, but it is cheap, and the cash is not the only asset ALJJ owns.

Tax shield

The company also has sizable net operating loss carryforwards, and the latest annual report provides some details:

At September 30, 2012, the Company had a net operating loss carry-forward for federal income tax purposes of approximately $258 million that expires from 2020 through 2028. The use of approximately $36 million of this net operating loss in future years may be restricted under Section 382 of the Internal Revenue Code. The realization of the benefits of the net operating losses is dependent upon sufficient taxable income in future years. Lack of consistent future earnings, a change in ownership of the Company, or the application of the alternative minimum tax rules could adversely affect the Company’s ability to utilize these net operating losses.

Additionally, if the Merger is completed, the Company’s ability to utilize our NOLs to offset future tax liabilities may be limited even if it acquires another business which generates taxable income. For example, if it takes the Company substantially more than one year to acquire another business, it may be treated as having liquidated for U.S. federal income tax purposes, which could prevent the Company from being able to its NOLs to offset future income of the new business.

Some of these assets have presumably been used in the sale of the KES division. ALJJ had a negative book value of $13 million before the sale, and after the sale but before the tender offer it had $51 million net in cash. I’m not an expert (far from it!) on US tax rules, but it would seem to me that this would require the company to recognize a gain of $64 million. This would reduce the carryforwards from $258 million to $194 million. $36 million of this amount is restricted, so I’m going to assume that the effective amount is closer to $158M.

With an effective tax rate of 35% this would mean that the company would be able to shield itself from paying $55 million in income taxes. This is however absolutely not the value of the tax shield because it’s probably not easy to generate $158 million in income between now and 2028. We are also talking about cash flows that are far in the future, and therefore should be discounted with an appropriate discount rate.

Since we have no idea what the income characteristics will be of a potential future business it’s going to be a big guess, but just to get a ballpark figure the following example. Lets say that that we can buy for the $27 million in cash a business that generates $3 million in income a year while income grows 10% a year. This would generate a total of $108 million in income between now and 2028 (and potentially a $37 million tax liability) so we would be able to use up a fair amount of the NOL carryforwards. But the present value of not paying those $37 million in taxes is, when we use a 10% discount rate, ‘just’ $14 million. Since you can’t be guaranteed to buy a profitable business, and there are a lot of other uncertainties as well, I would guess that the present value of the tax shield is somewhere between $5 million and $15 million.


One of the attractive aspects of the merger arbitrage, the initial reason I got involved in this name, is that the chairman of the board, Jess M. Ravich, would not tender his shares. This increased his stake from 22% to a bit more than 43%. That’s a good reason not to do anything stupid with the cash! The fact that he did not tender at $0.84 also indicates that he thinks ALJJ is worth more than just the cash alone. What’s perhaps a negative is that he recently joined TCW as group managing director, so how much time can he spend on ALJJ?

A possible catalyst

There is potentially also a catalyst for unlocking the value in ALJJ, and that is the fact that the company must acquire a new business in approximately one year in order to keep the NOL carryforwards valid (see the quote on the NOLs above). If this doesn’t happen I will assume that the cash will be returned to shareholders. The press release that was issued when the sale was announced contained the following language:

Upon completion of the Merger, ALJ will have no or nominal operations and, other than the cash proceeds, no material assets. ALJ intends to retain the remaining proceeds from the Merger for future acquisitions. At this time no specific acquisition targets have been designated and there can be no guarantee that ALJ will designate a suitable target within any particular time frame, or at all. Further, even if a target is identified, there is no guarantee that ALJ will be successful in acquiring such target on commercial terms or at all. Such a target company (or assets) might be in any industry. In the event that ALJ is not successful in acquiring one or more operating businesses within a reasonable period of time, the Board of ALJ will determine an appropriate course of action with respect to ALJ’s remaining cash-on-hand.

I’m thinking that the only appropriate course of action will be a return of capital at that point, and that would not be a bad outcome. With $0.94/share in cash you could be looking at a 25% return for just waiting and seeing nothing happen. A more uncertain outcome valuation and return wise is a successful acquisition of a business. But since the value of the NOL carryforwards would be preserved in this scenario I think it’s actually preferable.


After the completion of the merger and tender offer ALJJ isn’t the most exiting business in the world: it’s just a cash box doing nothing. Nevertheless I think it’s quite attractive at current prices. It’s trading at a 20% discount to cash/share, there are sizable tax assets and we have an insider that has a lot of skin in the game and a good track record. So instead of selling the remainder of my shares I actually bought some more.

Rating: on a scale of one to five I’m going to give this idea two stars. I’m not expecting huge returns, but I also don’t think it’s very risky: think it’s a good spot to park some cash.


Author is long ALJJ

Financial Shenanigans on UTStarcom

I’m currently reading Financial Shenanigans by Howards Schilit, and it’s about accounting gimmicks and fraud in financial statements. The book is filled with examples of both, and you see a lot of well known companies discussed. You have the usual suspects such as Enron and Worldcom, but also well known tech companies such as Intel, Microsoft and Cisco don’t escape the spotlight. Certainly recommended reading for the serious investor. To my surprise it even has a few sections on UTStarcom, a pretty obscure name in my book:

From chapter thirteen, about boosting operating cash flow:

Be Wary of Dramatic Improvements in CFFO. Telecom equipment manufacturer UTStarcom reported markedly improved CFFO in early 2008. After a dismal 2007, in which it logged four consecutive quarters of negative CFFO (for a total cash burn of $218 million), UTStarcom suddenly reported positive cash flow of $97 million in March 2008. Investors could have readily noticed that the cash flow turnaround resulted from a number of particularly aggressive working capital actions. A quick peek at the Balance Sheet revealed a $65 million drop in accounts receivable and a $66 million increase in accounts payable. The 10-Q gave more insight and mentioned one of those “management decisions” we warned you about in CF Shenanigan No. 1 with the infamous Computer Associates. (See the accompanying disclosure from UTStarcom’s March 2008 10-Q.)

UTStarcom proceeded to report negative operating cash flow throughout the rest of 2008. Despite the $97 million in positive CFFO during the first quarter, the company ended the year in a hole, having burned through $55 million in operating cash flow.

The company is mentioned again in chapter fifteen, about distorting balance sheet metrics:

Watch for Increases in Receivables Other Than Accounts Receivable. UTStarcom pulled a similar switcheroo in 2004 by taking more payment in the form of “bank notes” and “commercial notes.” Since these notes receivable were not categorized as accounts receivable on the Balance Sheet (in fact, the bank notes were considered cash), UTStarcom was able to present a more palatable DSO to investors, despite a severe deterioration in its business. Diligent investors could easily have spotted this improper account classification by reading UTStarcom’s footnotes. As shown in the accompanying box, the company disclosed clearly that it had accepted a substantial amount of bank and commercial notes in place of accounts receivable.

UTStarcom is still using this practice, but the impact of this accounting maneuver is at the moment (probably) insignificant. In 2004 the company had $100 million of bank notes receivable (that were classified as cash), while at the end of 2011 (date latest 20-F) UTSI had $2.4 million in bank notes. We don’t know what the current status is because quarterly results are released without footnotes. UTSI’s working capital management is probably still quite aggressive given the small amount of receivables on the balance sheet, and we also learn in the latest 20-F that the company does have an accounts-receivable factoring line of $31.8M that can be used to sell receivables from China telecommunication operators.



Ugly, but cheap: UTStarcom Holdings Corp. (UTSI)

When I see companies that repurchase large amounts of their own stock my curiosity is usually piqued. It’s even more interesting when it’s a Chinese company with a large cash balance because in this case the share buybacks are killing three birds with one stone. It not only shows that management is willing to return cash to shareholders and is capable of sensible capital allocation, it’s also proof that at least part of the cash balance is real. Before continuing the discussion, some quick stats on the company in question, UTStarcom:

Last price (Feb 8, 2013): $0.98
Shares outstanding (Jan 10, 2013): 117,068,276
Market Cap: $114.7M
P/B*: 0.57x
P/NCAV*: 1.11x
Cash/share*: $1.56
* Based on quarter ending 30 September 2012, adjusted for tender offer completed 10 Januari 2013

Share repurchases

UTStarcom, that aims to become “a next generation media company”, has been repurchasing shares on the open market since Augustus 2011, and the last time they provided an update on the share repurchase program the company had bought back approximately $14.2 million worth of shares. At the time this represented roughly 10% of the outstanding shares. Not too bad, but apparently this was not going fast enough since at the end of November the company launched a tender offer to repurchase $30 million worth of stock at $1.20/share, reducing the share count with another 17.4%.

The tender offer was completed early January, and what is perhaps most interesting is that just 63.4M shares were tendered in the offer. That was at the time just 44% of all outstanding shares while the tender offer was made at a substantial premium to the price a day before the offer was made (52%), or the average trading price of the past several months (~20%). I think there are two possible explanations for this, and both are favorable. The obvious explanation is of course that multiple large shareholders think the value of the company is well in excess of $1.20/share. If they are right you have a real bargain at today’s prices. The other explanation is that a large part of the shareholder base is simply stupid. This doesn’t have to imply that the company is currently cheap, but it would mean that there is a high probability that the share price does not reflect intrinsic value.

The directors and executive officers of the company did not participate in the tender offer, but since insider ownership is quite low I don’t think this tells a whole lot. More interesting is that their biggest shareholder (Shah Capital Management) did not sell shares in the tender offer, and actually increased their position. They now own 17.7% of the stock, and their latest form SC 13D/A contains an interesting note:

Recently, reporting person proposed the following action to the issuer:

– encourage management to monetize over a billion dollar carryforward losses by selling related subsidiaries in the US

So this is not only a nice hint where we should look to find some ‘hidden’ value, it also shows that the biggest shareholder is actively working in trying to unlock this value. Looking at some older SC 13D/A filings from Shah Capital it seems that management does listen. In July they proposed not only the above, but a few more value enhancing actions:

Recently, reporting person proposed the following action to the issuer:

– make a tender offer to buy back extremely undervalued shares
– encourage management to monetize over a billion dollar carryforward losses by selling related subsidiaries
– announce a special dividend in light of over $285 million cash held by the company

There hasn’t been a dividend, but spending $30 million in a tender offer to repurchase stock seems like a pretty good use of capital. I also think that their regular stock buyback program is still active. When the tender offer was launched the company had 143.7M shares outstanding, and after the tender offer just 117.1M. That’s 1.6M shares less than what you would expect based on the 25M shares repurchased in the tender offer. They have been keeping this quiet: previously UTSI provided a monthly update on the share repurchases.

Small note about Shah Capital: UTSI seems to be a pretty significant holding for them. Their stake is worth ~$21M while they had $275M AUM at the end of 2011. They also have a small long position in Suntech Power (STP). I’m short

Balance sheet

The next piece of the puzzle is the balance sheet. As is visible below the company does have a lot of cash of cash on the balance sheet. The balance needs to be adjusted downwards by $30 million since this money was spend in the tender offer, but even after this adjustment there is $1.56/share in cash while there is no debt.

UTStarcom Holdings Corp.

Unaudited Condensed Consolidated Balance Sheets

September 30,

December 31,




(In thousands, except par value)

Current assets:

Cash, cash equivalents and short-term investments

$                    213,091

$                    303,998

Accounts and notes receivable, net



Inventories and deferred costs



Prepaids and other current assets



Total current assets



Long-term assets:

Property, plant and equipment, net





Intangible assets, net


Long-term deferred costs



Other long-term assets



Total assets

$                    505,935

$                    600,940


Current liabilities:

Accounts payable

$                      22,836

$                      23,530

Customer advances



Deferred revenue



Other current liabilities



Total current liabilities



Long-term liabilities:

Long-term deferred revenue and other liabilities



Total liabilities



Total equity



Total liabilities and equity

$                    505,935

$                    600,940

There are sizable liabilities on the balance sheet though, but these are mostly related to future period revenue that hasn’t been recognized yet and the company also has offsetting assets in the form of deferred costs. I haven’t totally figured out how to value those assets and liabilities. The company has a total of $158M in inventories and deferred costs while there is $143M total in deferred revenue. I would assume that when the company recognizes the deferred revenue it will recognize at the same time the deferred costs, but I don’t know how profitable this revenue is and if the company needs to incur additional costs before the service and/or product can be delivered to the customer (and the revenue can be recognized). The same can be said about the $85M in customer advances and the $53M in prepaid assets. How much money, if any, does the company need to spend to turn the $85M in customer advances into revenue?

So while I’m not sure what the exact asset value of the business is I do think one thing is clear: the majority of cash that is on the balance sheet is excess cash that can be used to invest in new ventures or be returned to shareholders.

Tax assets

The filings of Shah Capital Management pointed me in the direction of significant off balance sheet assets. The company generated large losses in the past and it has large net operating loss carry forwards in various countries around the world. These assets have the potential to be more valuable then the company itself. We learn in note 15 of the latest 20-F filing that the company has $477 million in deferred tax assets that are offset by an almost equally large valuation allowance.

I don’t know how easy it is to monetize these assets. Shah Capital Management proposes to sell the related subsidiaries in the US, but as far as I know “a change of control transaction” invalidates the NOL carryforwards. Maybe they can be preserved if the transaction is structured sufficiently creative?

As of December 31, 2011, the Company’s U.S. federal net operating loss carryforwards were $366.7 million and expire in varying amounts between 2026 and 2032. As of December 31, 2011, state net operating loss carryforwards were $293.6 million and expire in varying amounts between 2012 and 2032. The Company has concluded that these federal and state net operating losses did not meet the more likely than not standard contained in FASB ASC 740-10 and has therefore placed a $142.8 million valuation allowance against the related deferred tax assets.

Given the fact that UTSI’s market cap is currently around $115 million I think it’s obvious how valuable the tax shield could be, if it’s indeed possible to realize the value by selling the US subsidiaries. Otherwise the company needs to generate significant profits itself, and given it’s history that could prove problematic. Buying an already profitable company is also an option, but given the size of the carryforwards it’s not going to be easy to fully use them.

Historic performance

Valuing UTSI based on it’s past results is a futile exercise, and that’s a good thing because the billion dollar in carryforward losses didn’t come out of nowhere. The company IPO’ed at the height of the dot-com bubble in March 2000, and the share price peaked that month at almost $88/share. Since then things have been going downhill, and the past 5 years the company managed to generate a $623 million loss.

Luckily the company hasn’t maintained it’s previous course, and it has restructured it’s operations significantly, starting in 2009. The company divested it’s IPTV business at the end of Augustus 2012 and simultaneously appointed a new CEO. A few months later the company unveiled a new strategic plan promising to transform itself in a higher growth and more profitable business. How successful the company is going to be remains to be seen, but at current prices you don’t need them to execute flawlessly. An average performance and profitability is already going to be great given the current starting point.

While there is a lot of uncertainty with regards to the future prospects of UTSI one thing that is good to see is that it is, after the latest divestiture, the company is not hemorrhaging cash. It could very well remain a melting ice cube though. Adjusted for the latest divested division the company had a $8.8 million operating loss for the past nine months, and the company expects to be “slightly below operating cash flow breakeven in 2012”. Adjusted operating cash flow for the past nine months is minus $5 million. Last year the company was actually profitable for the first time in a long time when it reported 21M in operating income.

The China factor

US listed Chinese companies are often cheap because investors are (rightly so) unsure if what they are buying is real. I’am not sure if this is a factor for UTSI: their historic financial performance is more than enough not to like their shares! And if you dig a little bit it’s not hard to find some other ugly things in the companies past, such as issues with their internal controls and possible violations of the Foreign Corrupt Practices Act.

While the business is ugly I’m confident that it’s real. The poor historical results itself are a good indication, and we have recently also seen that at least part of the cash is real thanks to the large share buybacks. The company also has a lot of ties to companies outside China. A large shareholder (owning 10.2% pre tender offer) and big client is for example SoftBank, a large Japanese telecommunications company with a ¥43 billion market cap. If someone would know if the company is real it’s them. The recent change of the CEO is also good news: I don’t think it’s likely he would have an incentive to continue a fraud of his predecessor.


As already mentioned insiders own a very small part of the company, and while that’s something I don’t like to see it’s not that weird in this case since there has been a lot of turnover in the management positions. Hong Liang Lu, a cofounder of UTSI and currently a board member, is the biggest inside owner with a 2.4% stake. While the companies directors and executive officers did not participate in the tender offer it seems that Hong Liang Lu has been selling shares and reducing his stake. He owned 2.6% last July when the latest proxy statement was released.

What is good to see is that shareholders are represented on the board. BEIID owns 7.9% of the outstanding shares and has part of a stockholders rights agreement the right to appoint one director to the board. They are represented by Xiaoping Li who was elected chairman of the board after the IPTV divesture last year.

Random note: one of the directors on the board (Tianruo Pu) used to be the CFO of China Nuokang Bio-Pharmaceutical, a name that the regular readers of this blog will recognize. NKBP went private successfully last Thursday, making me some money in the process.


UTStarcom is a company with an ugly past and an uncertain future, but at the same time it’s really cheap. It’s trading at a 40% discount to their cash balance and the off balance sheet tax assets are potentially very valuable. The current management team has also demonstrated that they are listening to shareholders and are capable of good capital allocation by buying back a bit more than 17% of the outstanding shares in a single transaction. UTSI is not an investment without risk, but I think it’s just too cheap to pass up.

Rating: on a scale of one to five I’m going to give this idea two stars. I think UTSI is really cheap, but quite risky at the same time. This certainly could turn out to be a case of a melting ice cube, or worse!


I will be long when you are reading this, but not going to buy a big position.