ASCMA : A cash-rich play

Companies trading at below net cash on hand are favorite investigative targets of value investors. Back in the Depression era, and during the brief market bottom in 2009, such stocks were plentiful. These days, however, such net cash companies are typically trading below cash for very good reasons, most commonly, because they are losing money and the cash pile is expected to shrink. Nevertheless, once in a blue moon, one comes across a net cash company with actual hidden earnings and growth prospects. ASCMA is one such company.

Ascent Media was spun off in May 2008 from Discovery Holdings (now Discovery Communications DISCA), the largest provider of non-fiction media and entertainment, and the owner of Discovery Channel and Animal Planet. Ascent Media provides support and post-production services to content producers, including digital conversion and enhancement, formatting, and distribution via satellite and the internet to worldwide movie theaters and TV stations. The company has no long-term debt, and total liabilities of $96M is offset by $97M in receivables. This leaves the company with $383M in cash and tradeable securities (consisting of diversified corporate bond funds), plus another $190M in long term assets. All this is currently trading at a market capitalization of about $370M, or below net cash. This means that we essentially get the $190M of long-term assets for free!

Why is ASCMA so undervalued? Firstly, it was spun off in 2008 through distribution of ASCMA shares to shareholders of Discover Holdings. Many of those shareholders found themselves holding shares of a business they did not fully understand nor want to understand, and proceeded to sell the shares indiscriminately. The resulting rapid decline in the stock price has baked in low expectations for this company. Also, as a newly spun-off company, there is no analyst coverage. Secondly, there are no comparable publicly traded companies on which one can benchmark. Most post-production houses are in-house divisions of large motion picture companies such as Walt Disney and Paramount Pictures, which typically do not break out their financial performance. The closest publicly traded companies are specialized outfits such as Technicolor (TCH) and Dolby Laboratories (DLB), which are not really comparable since ASCMA owns a much broader set of post-production companies and is more diversified. Lastly, the turmoil brought about by the 2008-2009 financial crisis has also taken a toll on its business. Advertising rates have plummeted, and processing of commercials have historically contributed as much as half of ASCMA’s revenue. (However, anecdoctal reports suggest that TV advertising rates will recover this year.) Mergers of cable companies have also weakened ASCMA’s negotiating position for its services. Certainly, the fact that ASCMA had an net loss of $50M in 2009 has scared away all weak hands.

What is the value of ASCMA’s $190M worth of long-term assets? ASCMA’s assets are mainly property and equipment at approximately 56 sites worldwide, including a satellite earth station in Minnesota, and leased satellite facilities in Singapore. With these facilities, ASCMA provides a variety of post-production services, including converting film into digital masters, digital enhancement and special effects, formatting content and commercials into a continuous feed for TV and cable, and distribution of commercials and shows worldwide through satellite and Internet. It also occasionally provides engineering consulting to companies who are trying to design multimedia delivery networks, such as Motorola. The profitability of this business is hard to estimate. Certainly, recent performance has been dismal, given that in 2009, ASCMA had a net loss of $50M. There appears to be 2 main reasons for this lack of profitability. Firstly, in 2009, there was a dramatic drop-off in the engineering consulting business, and more modest declines in other lines of business, which is understandable given the 2009 economic climate. Secondly, Discovery seems to have acquired its ASCMA assets in a piecemeal fashion with no real attempt to streamline costs, and as a result, there may be duplicative assets and inefficient cost structures.

However, I am optimistic about the value of the $190M of long-term assets. Management has stated that it is streamlining operations, and indeed has been selling off assets. Due to these asset sales, despite losses in operations, the cash pile has actually grown from $200M in 2007 to over $300M in 2010, which is definitely atypical of companies trading at net cash. Notably, all recent asset sales have resulted in ASCMA booking gains, an amazing feat considering that these sales took place in a weak economic environment, suggesting that the $190M is an underestimate of the true value. Also of note is that goodwill has been impaired to zero, and the $190M of assets is a fully depreciated estimate of the value of property and equipment, with no accounting for any possible intangible value. However, there is still the matter of whether the asset sales will be sufficient to offset losses at the operating level. Management has articulated a strategy of asset sales to streamline operations, retaining enough assets to provide an end-to-end service to content providers, from post-production processing to distribution, which seems to be a rational strategy. There will always be a demand for post-production services from advertisers and small production houses. Production houses will be leery of contracting these essential processes out to the post-production outfits of major motion picture companies, who are direct competitors. ASCMA is the only major independent post-production company that can provide a full suite of services. It processes about 70% of all TV commercials in the UK and 35% of TV commercials in the US, and also processes major motion pictures such as “The Hurt Locker” and TV productions like “House”. Furthermore, industries relying on creativity, such as the fashion industry and the movie and advertising businesses, tend to be fragmented and stay fragmented, because small outfits with good ideas continually enter the industry. There is no apparent reason why post-production services cannot be run on a profitable basis. There may be a temporary over-capacity due to decline in advertising and content volumes, but as in most cyclical industries, what eventually happens is that marginal and poorly-capitalized providers are shaken out of the system, and the supply-demand equilibrium is restored. Based on ASCMA’s first quarter 2010 results, it appears that operating performance is near break-even, and cash flow is actually positive again (even after excluding asset sales). While the value of ASCMA is hard to estimate, I think that asset sales of duplicative assets will more than make up for operational losses while the company and the industry as a whole streamlines into a more sustainable cost structure, and therefore I estimate that ASCMA should be worth its book value of around $570M ($380M cash plus $190M assets), or about $40 per share, a gain of 50% from its current price. This is obviously just a stab at valuation. The key point is that the cash pile is growing and not shrinking even in a weak economic environment, although the cash levels may be very volatile based on the timing of asset sales and business recovery.

Is the current management capable of carrying out its strategy? The major shareholder is John Malone, who owns 80% of the Class B supervoting stock in addition to Class A ordinary stock, and has 30% of the voting power. Malone is a veteran businessman in the media business, having been CEO and Chairman of Liberty Media and DirectTV. Malone is known to be an aggressive businessman with a keen eye for value. Interestingly, Malone has recently spent $1M of his own money to purchase even more shares of ASCMA. Another interesting name that caught my eye in the shareholder list is Mario Gabelli, a notable value investor who owns 8.8% of ASCMA. With these two veteran value-oriented investors guiding capital allocation decisions, I am confident that ASCMA will emerge as a streamlined, cost-efficient, and cash-rich post-production services company.

What are the risks associated with this investment? As with investments in any cash-rich company, there is always a cash-conversion risk, where management can squander cash on a bad investment. However, given the business reputation of Malone as the controlling shareholder, I think that this is a remote possibility. Secondly, the economy can always tank again, taking advertising rates down with it. But even in this scenario, I think that the cash pile will act as a cushion to further stock declines.

Disclosure : I have a long position in ASCMA.