NexCen Brands Inc (NEXC) is a brand management company holding 7 brands in two different operating segments: quick service restaurants and footwear & accessories.

Across the brand network, the company operates approx. 1,700 retail stores for brands like Great American Cookies, Marble Slab Creamery, and The Athlete’s Foot.

The current arrangement provides another special situations investment opportunity, with the company’s liquidation providing potential returns for the patient value investor.

History & Financial Situation

NexCen purchased the rights to the seven brands back in June 2006.  Since then, the stock has plummeted, as the company has lost money every year since 2005 while book value per share has been negative since 2008.

NEXC took on a great deal of leverage as it expanded its brand portfolio, borrowing over $138m under its credit facility in 2008 in order fund the acquisition of Great American Cookies.

However, the investment did not pay off, and the company struggled under the debt burden, casting doubt over whether it could continue as a going concern.

From the most recent 10-K, NEXC’s

“Credit Facility obligates us to make a scheduled principal payment of $34.5 million on our Class B Franchise Note in July 2011. We currently do not hexpect that we will be able to meet this obligation.”

As a result of the debt load, the company began seeking strategic alternatives for its debt and capital structure with the goal of maximizing return for shareholders.

Strategic Asset Sale

On May 13, 2010, NEXC announced an agreement to sell its franchise businesses to an investment firm with significant franchise experience for $112.5m, subject to stockholder approval. The proceeds would be used to pay off the company’s credit facility.

The definitive proxies for the transaction were filed on June 11, 2010, with special shareholder meeting scheduled for July 29. The proxy described the asset sale of the majority of the company’s assets, followed by a dissolution and liquidation of the company.

On July 30, 2010 the shareholders voted to approve the sale and dissolution proposal, effectively ending the company’s status as a working business.

NEXC Plan of Dissolution & Liquidation

According to the proxy filings, the company expects liquidation distributions in the range of $0.12 to $0.16 per share.

The stock is trading only slightly above the low point of the estimated range, providing a downward floor from a risk perspective but with significant upside.

Potential Catalyst

Further increasing the chances that the company will end up distributing cash towards the high end of the range, NEXC announced the hiring of a strategic consulting firm who will handle the wind-down of the company, including the distribution.

The fee for this service is $100k, money that could potentially go to shareholders. However, I like this arrangement because the terms of the agreement provide an incentive fee in the event that at least $8m is distributed to company shareholders.

I’m a big believer that people will focus exclusively on what they are incentivized to do – in this case, it should influence the consulting firm to quickly wrap up the transaction in a timely fashion and for the lowest cost.

Since the biggest risk in these transactions is the final closing being bogged down in legal and logistical nightmares that take a great deal of time, I view this arrangement as a very positive development for shareholders.

Return Scenarios

Major Risks

Although the company is estimating the low range of net proceeds to be $0.12, there remains the possibility that shareholders might not receive any compensation at all.

Also, despite the consulting arrangement, these type of liquidations can sometimes take years to wind-down, as the company pays down creditors and satisfies remaining obligations.

Conclusion

While there is definite risk in the deal, substantial upside remains if the consulting company can finalize arrangements in an orderly and efficient manner (right in line with their incentive arrangement).

I believe that the firm will do everything in its power to reach their success target of $8m, allowing for a potential return of 12.14%.

I’m adding NEXC to the Value Uncovered portfolio at Friday’s closing price of $0.123. The record date for the liquidation distribution is today, Sept 13.

Disclosure

Long NEXC

A collection of value investing ideas from the previous two weeks:

Contraction Expansion

Barel Karsan lays out the risk/reward for SIFCO Industries (SIF), a stock recently featured here at Value Uncovered (See: SIFCO: A Contrarian Investment). The stock appears to be very cheap, but management is rolling out an expansion strategy during a cyclical downperiod for the company.

The question remains whether the business is back on the upswing (and management is correctly anticipating) or whether the company will experience another down year or two (and potentially struggle by not conserving  cash).

Risk Arbitrage: The Battle for 3PAR

Hunter over at Merger Arbitrage Investing has a nice writeup on the bidding war between Dell Inc (DELL) and Hewlett-Packard Co (HPQ) for 3PAR Inc (PAR), the global provider of utility storage systems.

In a little over a month’s time, the bidding war increased the purchase price for 3PAR from $1.15B to $2.35B, as the mega-tech giants battled over control of the company.

While many special situations investments try to capture a thin, ‘risk-free’ spread, a good portion of long-term value arises from bidding wars between potential acquirers.

InfoSpace Inc.: Cash + Cash Flow + Big NOL = Cheapness & Change Agent

Featured at GuruFocus, Infospace (INSP) is a meta search engine that has suffered greatly since the dot-com bubble (the stock hit a split-adjusted price of $1,190/shr in March 2000 compared to a current price of $7.19/shr!)

From an value perspective, the company has $6.25/shr in net cash on its balance sheet, generates solid FCF, and has a huge ($815m) pile of Net Operating Loss (NOL) tax carryforwards that could potentially be valuable to a strategic acquirer.

Acquirer Buys Cash at a Discount

Barel Karsan has another great post on Qiao Xing Mobile (QXM), a mobile handset manufacturer in China. QXM has appeared on every Graham, NCAV, or NNWC screen over the past several months, as the company is sitting on over $265m of net cash.

A recent buyout offer from majority shareholders (usually a great situation that unlocks potential for value investors) values the company at only $206m, well under the net cash balance.

The situation shows how difficult it can be to unlock value for minority shareholders, even in a buyout/liquidation situations.

Class #1 – Introduction to Value Investing

While I usually feature specific stock recommendations on Weekend Values, I came across this series of class notes that was interesting enough to pass along.  The notes were typed up by an anonymous student at a graduate business school during various lectures from 2002-2007.

Browse through the related Scribd documents for even more insights.

Disclosure

No positions.

Pinnacle Gas Resources (PINN) is a micro-cap stock that holds natural gas properties in the Powder River Basin of Wyoming and Montana. The company leases approx. 406k gross acres of undeveloped land and 15 billion cubic feet (bcf) of proven natural gas reserves.

The company has reported large operating losses for the past three years, with 2009 being especially brutal. PINN reported a net loss of $68.75m as natural gas prices dropped significantly, from an average of $6.24/Mcf in 2008 to only $3.07/Mcf in 2009.

Strategic Going Private Transaction

On February 24, 2010, Pinnacle announced a going private transaction led by Scotia Waterous, the oil & gas M&A division of Scotia Capital. From the press release,

“The Special Committee considered a range of potential alternatives, including continuing to operate as an independent entity, possible sales of certain assets, the Company’s ability to issue additional equity in a public or private offering, and restructurings of the Company’s outstanding debt”

According to the board, this transaction was the best alternative for company shareholders.

Agreement Terms

The going private deal is a $0.34/shr cash offer, valuing the company at $11m. The merger required shareholder approval and the waiver of certain lending conditions of Pinnacle’s credit facility.

Under the merger agreement, shareholder approval had two parts: 1) a majority vote of all shares & 2) a majority vote of all shares not owned by DLJ Merchant Banking Partners III (DLJ) and the company’s senior executives.

On August 11 2010, PINN’s shareholders voted to approve the merger, with 72.6% voting in favor.

Credit Agreement Default

The last condition for the completion of the transaction is a waiver by the company’s senior lender, the Royal Bank of Scotland.

Pinnacle borrowed heavily in 2007 – the drop in gas prices and the poor performance of the business forced severe restrictions on the company’s credit facility.

The credit agreement was modified a total of 7 times on the $5.1m balance.

According to the latest revision, the Final Maturity Date was set at

“(i) June 15, 2010 or (ii) the date that is thirty days following the earlier of (A) the date the merger is withdrawn or terminated in whole or in part or (B) the date that the lenders have been advised that the merger will not proceed.”

The company missed payments on both July 1 and Aug 1, effectively breaching the agreement not only with the lender, but with Scotia Waterous as well.

However,

“Scotia has indicated at this time that it will not waive the default; however, it has not terminated the Merger. Accordingly, the Company and Scotia are proceeding with the Merger”

There has been no further info since the August 16 quarterly filing.

Risks

This is a tiny transaction, and there were several lawsuits (since settled) surrounding the management team and their relationship to the acquirer both pre and post merger.

Typically, these types of transactions close very quickly after shareholder approval, but the deal has been languishing for almost a month.

If Pinnacle does not receive a waiver from its lender, the full $5.1M becomes immediately due – since most of the company’s assets are tied up in natural gas (under the ground!), this would most likely force the company into bankruptcy.

Valuation

The stock dropped over 10% towards the end of the day on no news and slightly above average volume – amazingly, $0.29 has been the lowest price since the merger was announced over 6 months ago.

Conclusion

The drop in price at the close today is a very suspicious indicator, possibly indicating that the market does not believe that the company’s lender will give the go ahead.

Although the spread is very attractive, the downside risk is basically bankruptcy.

So, is the deal worth the risks? Any reason why the RBS would refuse a final waiver after such a long road?

Disclosure

No positions.