Strategic Alternatives & Buyouts

by JT McGee

chess, black and white chess pieces, strategy, buyoutsOn Thursday, one of my stock picks for 2012 announced it would seek out “strategic alternatives” to boost shareholder value. To fully embrace the concept of finally working for shareholders, Adams Golf will reach out to Morgan Stanley to find some “alternatives.”

The heavy use of the word “alternative” makes this feel like some drug deal. Strategic alternatives essentially means selling the company to reward shareholders.

More specifically, the company will look for a suitor that has some kind of strategic value for the company’s assets.

Strategic Benefits of a Buyout

There are a few inherent qualities to Adams Golf:

  1. Brand equity – Adams Golf is “the brand” when it comes to hybrid golf clubs, a club growing in popularity among players. It has won this category in Golf magazine for four years in a row.
  2. Broad platform – In my original post at InvestitWisely, I talked a lot about Adams Golf’s purchase of putting company Yes! Golf. In my view, Yes! Is worth far more than the $1.65 million price tag Adams paid, as it opens up new markets overseas. More importantly – and any distributor knows this – two spots on a store shelf are far better than 1. 😉
  3. Pure play – The unfortunate reality is that bankers and lawyers cost a lot of money. Selling and pitching a firm isn’t as easy as drawing up a pitch book and allowing the company to sell itself. Luckily, Adams Golf is a pure play in that is a golf company and golf company only. This definitely helps from the standpoint of valuation.

Name Your Price

Valuing the company is rather difficult, given its small size, the general cyclicality of the business, and the limited amount of free cash flow the company can spew to investors.

I like to value companies based on free cash flow, but you cannot value a growing company on free cash basis. Whatever income Adams generates is plowed back into more inventory, better product lines, and more sponsorships to sell more product the following year. There’s nothing wrong with that, but it does remove my preferred method of business valuation.

So instead I’ll have to rely on simple earnings per share, or accounting profits. Accounting profits are better left for tax collectors than investors, but prejudices aside I’ll play along.

These are my assumptions:

  1. The company can earn $1 per year or more per share.
  2. Growth for this firm with better management could very easily top 15-20% per year as international markets are maximized and cash flow is better invested.
  3. There aren’t too many companies interested in buying a golf company, which reduces the selling price potential considerably.

Given those assumptions and a healthy risk-adjustment I’ll give the income stream a valuation of $7-8, roughly equal to the current share price of $7.

But there is more to this company than long-term profits. Adams Golf is just another Pawn Stars stock, a company selling for less than the market value of its assets. Including a $6.4 million settlement with a previous insurance company, the firm has some $65 million in current assets and $78 million in total assets against current liabilities of $16 million. The company has no long-term debt.

Take the current assets and net out liabilities to find that the company has $48 million in assets that look a heck of a lot like cash. Interestingly, the company has a current valuation on Wall Street of only $54 million – the very reason why Adams has to consider so-called “strategic alternatives.”

Banking on Buyouts

The bottomline is that this firm is worth anywhere from $7-15, depending on how much you believe in it. I don’t golf, but I think it’s a fantastic brand, and I think it has a lot more potential than management and the market are allowing it to achieve. I don’t buy companies I don’t believe in 100%. As I said at InvestitWisely:

I’m in this company for a potential buyout play; it’s exceptionally cheap, and a classic value stock but with all the avenues for future growth.

In going forward, investors have a rare opportunity to get into a company that is doing everything right in an industry that the economy has wronged. As pure-play on consumer spending, Adam’s looks like an attractive wager in 2011.

Of course, that was also like 25-35% ago. I won’t let price get in the way of value, however.

So, depending on the “strategicness” of this “alternative,” I’m waiting on a check equal to at least $10 per share. I value bragging rights more than anything, and so I’m hoping Adams gets the deal done within a year at $10 or more. New 5% owners reporting a their positions plus a fight for the board is good for business. I love me some activist investing.

A move to $10 per share would be a 63.9% return from the 2012 opening price of ~$6.10 per share, creating a baseline return of just under 16% for my four stock portfolio.

I can dig it. Bring on the bragging rights.

Disclosure: I own ADGF stock. Also, I am not a financial analyst. I have no training in finance other than rudimentary accounting classes and a full credit hour in bowling. 😉

Photo by: Dan Zen

{ 3 comments… read them below or add one }

Rich March 16, 2012 at 00:04

Have any of the recent events and chatter affected your thoughts on valuation or the details of a potential sale?

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JT McGee March 16, 2012 at 10:56

Yes, but only to the upside. I think $12.50-14 per share is in play, especially since the most recent financial reports indicated a cash position of $18M, or about $2.25 in cash per share. A price of $12.5 per share makes this deal worth $100 million in total.

The Yes! brand is by far the best thing Adams has going for it. A well-capitalized buyer could work wonders with the strategic benefits of an additional brand name. Adams was worth buying because it was cheap before the Yes! Golf acquisition, and after the Yes! acquisition, it’s a much improved takeover target.

I’m keen on holding this company forever. That said, I won’t walk away from a hefty buyout. There are always more companies worth buying, no matter how much I like this brand, the story, and future growth potential.

I should disclose that I won’t be adding any more to my position here. If we get a deal, I’ll take it. But I’m already short on diversification and won’t concentrate into Adams further at the current price.

Reply

JT McGee March 20, 2012 at 00:07

Pfft, man I feel like a chump! $10.80 a share it is.

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