Some stocks are just made of money
Peerless Systems (
) is my Pick to Click
To summarize the characteristics of Peerless Systems, it would
be something like this.
- Generates positive free cash flow
- Has 90% margins
- No debt
- Buying backs shares like there is no tomorrow
- Trades at less than its NCAV
- CEO was previously a value fund manager and owns 20%
- Its licensing business will wind down sooner than later
resulting in no revenues
- Looking to change the business into a closed end investment
- Investment in a public micro cap not working out well
Let me show it another way.
(Click to enlarge)
PRLS Profitable Net Net
Peerless Systems is a net net selling below both NCAV and
- NCAV is $4.58. The current price is an 18% discount to
- NNWC is $4.30. 12% discount to NNWC.
Extremely cheap in terms of valuation.
Why is Peerless Systems So Cheap?
Everything becomes cheap for a reason. Peerless generates
revenue by licensing its technology for imaging solutions in the
digital image space. Manufacturers of printers, photocopiers,
scanners and other digital image OEM's have to pay Peerless.
The problem is that the printer business has been in decline for
a while. People just don't print as much as they used to. It's
easier than ever to store documents digitally and to share with
Multifunction printers were hot several years ago, but the
industry has been consolidating and Peerless understood that it
didn't stand a chance competing against OEMs directly and with
cheaper labor overseas. In 2008, Peerless sold the majority of
their technologies and has been milking the last few remaining
licenses it holds.
There is no growth prospect and the core operation is going to
become obsolete. But that also brings opportunity.
Is there Any Upside with Peerless Systems?
It's not the typical 100%+ upside that many net nets offer. For
a company in decline, the last quarter saw revenues increase by
79%. Yes it's just one quarter and yes the numbers are small ($0.6m
to $1.1m) so it's easy to dismiss it. However consider the way
Peerless Systems sells its licenses.
Most of the revenue until now came from selling block licenses.
A block license is where you are given a set quantity of licenses
to use. E.g if you buy Microsoft Office, you can only install the
software onto one machine. If you want to install it on 10
computers, you need to buy a bigger, more expensive license.
In the recent quarter, some accounts have moved to a pay per
unit license agreement. This is good and bad.
Good because single licenses are more expensive and brings in
higher revenue. Thus the 79% increase in revenue compared to the
last comparable quarter. Bad because customers are not committing
Because the company has eliminated expenses down to $0.3m, most
of the money from revenue will drop to FCF. If more customers
switch from the block license commitment to paying per unit, the
short term will see some good FCF generation. This gives Peerless
even more time to find the best use for their cash and to turn
their business in another direction because at the moment, cash
burn is a surplus.
I'll get to valuation later.
How Can I Lose Money?
Before discussing what Peerless is worth, or what it isn't, I
want to focus on the downside.
Protect the downside and the upside will take care of
Can you lose money with Peerless? Of course.
This investment is a bust if Peerless burns through its cash and
there are 3 main ways that Peerless Systems "burns" cash.
- Cost of staying public - approx $100k a year for auditing and
- CEO compensation - $445k in 2013, $653k in 2012.
- Loss on its stock investments - All of its marketable
securities (which is 11% of cash and equivalents) are held in a
microcap called Moduslink (
Peerless Systems will likely keep all three so that means the
real cash burn is going to be in the range of $500k - 800k a year.
The market value of the stock is a non realized amount so it isn't
a cash burn. I will ignore it in this scenario.
If Peerless did absolutely nothing, the cash burn will be around
800k at the upper range. With a current cash balance of $10m,
Peerless could technically stay afloat for 12 years. Being able to
survive for 12 years on breadcrumbs may sound impressive, but
remember that in such a situation, every passing year will see its
That's how you can lose with Peerless. It all comes down to how
the cash will be used.
Value Investor CEO in Charge
No big progress has occurred since the sale of its licenses in
2008, but the CEO is on the shareholders side.
is a former value fund manager and owns 20% of the company. His
interests are definitely aligned and his strategy has been to
reduce expenses and increase shareholder value.
(Click to enlarge)
(Click to enlarge)
Peerless Systems Share Buybacks
- 2009 shares outstanding: 17.7m
- Current shares outstanding: 3m
With the low liquidity, about 10% of the shares are being bought
back each quarter in the mid $3 range, well below book value and
NCAV. In an attempt to make something out of the company, Peerless
is also transforming the business into a closed end fund.
In the second quarter of fiscal 2012, we determined to
attempt to transition our primary business to the asset
management industry. In the third quarter of fiscal 2012,
Peerless Value Opportunity Fund ("PVOF") filed a
registration statement to conduct an initial public
offering of its common shares. Locksmith Capital Advisors
("LCA"), a wholly-owned subsidiary of Peerless, has entered
into a management agreement with PVOF to act as its
It will likely be focused on small value plays such as
ModusLink. The only thing is that ModusLink doesn't seem to be
working out well so far. As with all investments, a year or two is
too early to judge an investment so I won't conclude anything about
the MLNK investment yet.
We continued to hold a significant investment in
ModusLink during fiscal 2013. ModusLink experienced a
number of disruptive events during the year, including a
review of strategic alternatives which had no positive
results, an inquiry from the SEC, an internal investigation
which determined that certain client contracts had not been
"properly aligned with best corporate practices," a delay
in filing various periodic reports with the SEC, a
restatement of prior financial statements, various letters
from NASDAQ notifying ModusLink of its noncompliance with
NASDAQ Listing Rule 5250(c)(1) due to the company's delayed
filing of its periodic reports, and the departure of its
top two executives.
If Peerless Systems is able to register as Peerless Asset
)), this will serve as a catalyst. Until it happens though, it's
just an idea.
What is Peerless Systems Not Worth?
Let's kill the investment. Just assume the worst has
- No more sales
- All the customers have left
- The licenses are useless and its technology is out of
- MLNK goes bankrupt and market securities is written down to
- Peerless can't collect any of its receivables
Other than the company burning down, how could it get any worse?
Imagine this happening tomorrow, all at once. What's it worth?
How about $3.35, which is only 11% below the current price. The
world has basically collapsed on Peerless Systems, but its value is
only 11% lower? Here's the adjustments I made to the balance sheet
to reflect the above.
(Click to enlarge)
PRLS adjusted balance sheet
That's how cheap it is. So what I do know is that it isn't worth
the current price of $3.76. It also isn't worth $3.35 because it's
profitable on the top and bottom line and is seeing some short term
growth to further cushion the cash vault.
What is Peerless Systems Worth?
The stock price is made up of two parts. Stock price =
Fundamentals + Speculative, where speculative is just another way
of saying growth.
On the fundamentals side the balance sheet is super clean and
healthy with no cash burn. Tangible book value is equivalent to
NCAV and so I can safely say that the starting point is $4.58. On
the speculative side, it gets tricky because I'm trying to measure
the value of operations that I know will decline.
Professor Damodaran provides
3 ways to value distressed companies
that will liquidate.
- Estimate the present value of the expected cash flows in a
discounted cash flow model, and assume that the distress sale
will generate only a percentage (less than 100%) of this value.
Thus, if the discounted cash flow valuation yields $ 5 billion as
the value of the assets, we may assume that the value will only
be $ 3 billion in the event of a distress sale.
- Estimate the present value of expected cash flows only from
existing investments as the distress sale value. Essentially, we
are assuming that a buyer will not pay for future investments in
a distress sale. In practical terms, we would estimate the
distress sale value by considering the cash flows from assets in
place as a perpetuity (with no growth).
- The most practical way of estimating distress sale proceeds
is to consider the distress sale proceeds as a percent of book
value of assets, based upon the experience of other distressed
For Peerless Systems, option (1) and (2) are the same. Option
(3) is the same as selling it at NCAV value.
Performing a DCF with a starting FCF value of $0.6m with 9%
discount rate and 0% growth yields a value of $6.05. If the company
is to be liquidated, 100% of the value is unlikely to be
recognized. Taking 80% of the fair value makes it worth $4.84 in a
But Peerless is not in distress. It doesn't have any debt that
it can't pay back and it is unlikely Peerless will abruptly cease
to exist. So it will be worth more than $4.84.
I'm going to keep the limit to $5.00. More art than science
here. I've got my range then.
Low value: $4.58
Mid value: $4.84
High value: $5
I still have a 18% margin of safety on the low end and 25%
margin of safety on the high end. The upside isn't through the
roof, but when you think about the downside protection, Peerless
Systems is a stock well worth considering.
Click the image below to download the PDF tearsheet and DCF
Quiet Period Ends On Monday For Third Point