Value Investors: 3 Turnaround Stocks To Consider Now

By Bill Edson - October 2, 2012 | Tickers: AAPL, HPQ, NOK, PCRFY, SNE | 0 Comments

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Investors seeking cheaply-valued companies have to learn to analyze turnaround stories. These are businesses that have to change their strategies and products to survive.

The following companies were screened to find those which are producing net losses, but have histories of yielding dividends. These stocks can prove attractive if (1) they are discounted to compensate investors for the risk of a turnaround and (2) if management is truly committed to dividend payments in the long-run.

In addition to net losses over the past 12 months, there are descriptive stories which have helped drop the valuations of these companies to make them cheap. Some of these companies are more likely value traps than others.

Nokia: The Value of Patents

Nokia’s (NYSE: NOK) patent portfolio should be regarded as valuable because it could prove useful to the intellectual property war being waged across legal systems between rival mobile device companies. Big companies use patent portfolios to fight each other in court or as leverage to settle out of court. As long as these companies have stockpiles of cash and legal systems as battlegrounds, relevant unexpired patents will be valuable.

The purchase of patents for legal scuffles is very real. HTC’s conflict with Apple (NASDAQ: AAPL)relies on patents that it purchased from ADC Telecommunications in April 2011. The $13 billion purchase of Motorola Mobility by Google (GOOG) in 2012 was executed largely to gain access to its patents. This purchase has allowed Google to claim that Apple has infringed on patented technology including interactive voice commands, email notifications, location reminders, and video/phone players.

Nokia’s patents are estimated to be worth $7.5 billion while Nokia shares have a $10 billion market. Investors should note that its patent portfolio accounts for most of its market capitalization.

Japanese or Global Firms?

Two of the screen results are Japanese stocks. Fearful of stock market crashes, the Japanese investing public refuses to chase stock prices. The result is chronically low price multiples for Japanese stocks. 

Oddly, this may present an opportunity for global investors. Yes, Japan’s demographics and government debt/GDP ratios are shocking and depressing. But, these stocks do not do business solely in Japan. These stocks derive revenues (and hopefully in the future, earnings) across the globe. Foreign investors interested in these stocks can buy a global multinational on the cheap simply because its headquarters is located in Japan. The components and supplies for these companies are sourced from around the world, and their customers hail from around the world. Outside of legal or property right issues, the macroeconomic outlook for Japan does not preclude investment in these stocks any more than it would for General Motors (GM) or Apple.

Investors in 2012 should realize that the world is flat. Investors who fear the high value of the Yen and a potential reversal in exchange rates can hedge their currency exposure by buying put options on the Yen.

Hewlett-Packard is a Jim Chanos Short Call

Legendary short-seller Jim Chanos made news when he assessed Hewlett-Packard (NYSE: HPQ) as a short candidate. He claims that companies like Hewlett-Packard are in trouble in the wake of an Apple-led movement from personal computers to mobile devices. Mr. Chanos is concerned that Hewlett-Packard will refuse to age gracefully and instead will acquire other companies in desperate attempts to acquire lost market share.

First, investors should check to make sure that these beaten firms are cheap. After all, the common factor of bargains and “cheap for a reason” value traps is that they trade at low valuations. Both Hewlett-Packard and Nokia are trading at very cheap price-to-book and price-to-sales valuations.

Next, we should see if these firms are cash sinkholes. Mr. Chanos warned that R&D spending, which is immediately expensed according to U.S. GAAP (Generally Accepted Accounting Principles) is largely capitalized in an acquisition. This salient point would allow firms which engage in acquisitions to keep earnings free from R&D expense. Their peers that internally develop their brands and technology would be at a disadvantage in their financial statements since their earnings would be lower after expensing research and development costs. (Apple, for example, does not have an explicit acquisitions cash flow item.)

This means that investors should pay careful attention to acquisition expenditures and free cash flow adjusted for acquisition payments. Net acquisition cash flows were subtracted from free cash flow below:

(Values millions of dollars for all firms except Nokia, whose values are in millions of Euros.)

Mr. Chanos may be on to something! Hewlett-Packard has more R&D adjusted cash outflows than Nokia, which has had periods of cash outflows.

Corporate Restructuring: Hatching an Egg

There are no guarantees that management will act on behalf of shareholder interests. The lure of spending on sexy capital projects can overshadow shareholder begging for dividend payments. Similarly, management may cling to terminally-ill capital projects rather than judiciously sell non-core assets and underperforming segments to outside bidders.

A history of dividend payments helps screen these turnaround candidates for their commitment to shareholder interests. All of these companies on this list pass this screen.

But, Hewlett-Packard has a particularly nasty history of R&D-adjusted capital expenditures. Therefore, value investors seeking to harvest cash from turnaround stories should focus on Nokia, Panasonic (NASDAQOTH: PCRFY), and Sony (NYSE: SNE). These companies trade at low valuations because of reluctant domestic investment or a denial of the economic value of intellectual property. 

But there are other reasons investors should consider buying Panasonic and Sony. Panasonic recently received high ratings from Buyers Labratory LLC for its KV-S1046C document scanner. Panasonic also entered into a settlement agreement with Acacia Research (ACTG). This agreement brings closure to an ongoing patent litigation that was pending in the United States District Court.  

Meanwhile, Sony has been aiming high with its alliance with Olympus, after announcing that it will invest $644 million into the company and become its top shareholder. While the initial investment might cause you to hesitate, Sony has set a goal for its medical business alliance with Olympus of $2.6 billion by 2020, according to the Wall Street Journal. The duo aims to produce surgical tools, including endoscopes, armed with three-dimensional imaging and crystal-clear "4K" display technologies.

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