Cabot Microelectronics-A Masked Value Stock Part 3
Nikhil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
This is a part of my Behind the Curtain: Special Situations for Explosive Returns, series
I hope you have enjoyed this three part series. Feel free to comment on whether you like the three part series better, or if it would have been better to compress the information into a single blog, and of course I would love opinions on the material itself. In this final part, I will delve into Cabot’s recent attempts to buoy shareholder value, and explain why Cabot is a special situation investment that can offer outsized returns. Click to access Part 1:#mce_temp_url# or Part 2:#mce_temp_url#.
Cabot Microelectronics-A Masked Value Stock Part 3
The Special Situation Aspects:
While Cabot Microelectronics (NASDAQ: CCMP) has an attractive valuation without the special situation, the three special aspects of Cabot’s valuation are what make this investment extremely lucrative.
1. Insider Trading
This month, there has been lots of insider buying into Cabot Microelectronics. 95,170 shares have been granted to 11 insiders via options while 1 insider (who was among the insiders granted stock this month) sold his 13,000 shares. While insider selling can be for any number of reasons (specifically I think the one insider selling must have been trying to cash out quickly while he was up, rather than actually considering the stock’s valuation), insider buying or option exercise can only signal that insiders have optimistic expectations around the stock, which is why insider buying is considered such a powerful investment signal.
2. Short Float
The overall market seems to have an unmerited bearish outlook on Cabot, as seen with the 18.8% of shares that had been sold short as of Nov. 30th. Many assume that the 14% jump in Cabot’s shares that occurred after the special dividend announcement was a result of many of the shorts covering their shares(http://finance.yahoo.com/q/ks?s=CCMP+Key+Statistics, http://seekingalpha.com/article/313722-cabot-microelectronics-squeezes-shorts-and-pays-shareholders). I believe that the shorts remaining in the stock should provide a boost in Cabot’s shares if earnings manage to surprise analysts in future quarters (which inventory analysis predicts they will).
- Leveraged Recapitalization-Press Release Below:
• Proposed leveraged recapitalization with special cash dividend of $15 per share, or approximately $345 million
• Special dividend to be funded from cash balance and anticipated new term loan facility
• Increase in authorized share repurchase program to $150 million
“The company intends to pay a special cash dividend of $15 per share, or approximately $345 million in aggregate, to its shareholders during the first quarter of calendar year 2012. Approximately half of the dividend is expected to be funded from the company’s cash balance, and the remaining amount is expected to be funded with new debt. Payment of the special dividend is contingent upon arranging the associated financing with terms and conditions that are acceptable to the company. In addition, the Board has authorized an increase in the company’s existing share repurchase program to $150 million, from the previous available authorization of approximately $83 million. The company intends to continue to repurchase its shares from time to time in open market transactions, depending on market conditions, at management’s discretion.
The company expects to declare and pay the special cash dividend during the first quarter of calendar year 2012. Declaration and payment of the dividend is conditioned upon obtaining debt financing under terms and conditions that are acceptable to the company. The company expects to enter into a new term loan facility in the amount of approximately $175 million, with a maturity of no less than five years, and a new $100 million revolving credit facility, which is intended to be initially undrawn. The company is currently in discussions with financing sources and anticipates it will close on the new credit facilities in early 2012.”
While the share repurchase program should buoy earnings per share, the leveraged recap is where the valuation can really be affected. Keep in mind that before the dividend announcement, CCMP has traded this year at $52 per share. After the dividend, with higher debt, we can give CCMP a P/E of 17, 20% lower than its prior optimistic valuations. Based on forward 2012 earnings, this would give CCMP a post-recap value of $51 per share, giving CCMP a pre-recapitalization intrinsic value of $66 per share. Our own prior intrinsic value calculations (Part 2) match with this because adding back the dividend, we arrived at a pre-recapitalization intrinsic value of $61 per share.
Conclusion:
This valuation of Cabot’s business suggests a 35% upside to current market prices, offering an attractive investment opportunity. Cabot is unique in its financial position, while it has high exposure to the tech industry, the nightmare of value, it is a cash cow and a secure investment for a value investor like me.
Fool Blogger Nikhil Shamapant does not own shares in any company mentioned above and will not purchase shares in the next two trading days.
