NVEC: A Cash Plump Activist Target…For Icahn? by Investing Caffeine
Some might call Carl Icahn a greedy capitalist, but at the core, the 78 year old activist has built his billions in fortunes by unlocking shareholder value in undervalued companies. His targets have come in many shapes and sizes, but one type of target is cash bloated companies without defined capital allocation strategies. A recent high profile example of a cash ballooned target of Icahn was none other than the $591+ billion behemoth Apple Inc. (NASDAQ:AAPL).
His initial tweet on August 13, 2013 announced his “large position” in the “extremely undervalued shares” of Apple ($67 split adjusted). We have been long-term shareholders of Apple ourselves and actually beat Carl to the punch three years earlier when the shares were trading at $35 – see Jobs: The Gluttonous Cash Hog. Icahn doesn’t just nonchalantly make outrageous claims…he puts his money where his mouth is. After Icahn’s initial proclamation, he went onto build a substantial $3.6 billion Apple position by January 2014.
Icahn initially demanded Apple’s CEO Tim Cook to execute a $150 billion share repurchase program before downgrading his proposal to a $50 billion buyback. After receiving continued resistance, Icahn eventually relented in February 2014. But Icahn’s blood, sweat, and tears did not go to waste. His total return in Apple from his initial announcement approximates +50%, in less than one year. And although Icahn wanted more action taken by the company’s management team, Apple has repurchased about $50 billion in stock and paid out $14 billion in dividends to investors over the last five quarters. Despite the significant amount of capital returned to shareholders over the last year, Apple still holds a gargantuan net cash position of $133.5 billion, up approximately $3 billion from the 2013 fiscal third quarter.
Icahn’s Next Cash Plump Target?
Mr. Icahn is continually on the prowl for new targets, and if he played in the small cap stock arena, NVE Corp. (NVEC) certainly holds the characteristics of a cash bloated company without a defined capital allocation strategy. Although I rarely write about my hedge fund stock holdings, followers of my Investing Caffeine blog may recognize the name NVE Corp. More specifically, in 2010 I picked NVE Corp (NASDAQ:NVEC) as my top stock pick of the year (see NVEC: Profiting from Electronic Eyes, Nerves & Brains). The good news is that NVEC outperformed the market by approximately +25% that year (+36% vs 11% for the S&P 500). Over the ensuing years, the performance has been more modest – the +42% return from early 2010 has underperformed the overall stock market.
Rather than rehash my whole prior investment thesis, I would point you to theoriginal article for a summary of NVE’s fundamentals. Suffice it to say, however, that NVE’s prospects are just as positive (if not more so) today as they were five years ago.
Here are some NVE data points that Mr. Icahn may find interesting:
- 60% operating margins (achieved by < 1% of all non-financial companiesFINVIZ)
- 0% debt
- 15% EPS growth over the last seven years ($1.00 to $2.29)
- Cutting edge, patent protected, market leading spintronic technology
- +7% Free Cash Flow yield ($13m FCF / $194 adjusted market value) $294m market cap minus $100m cash.
- $100 million in cash on the balance sheet, equal to 34% of the company’s market value ($294m). For comparison purposes to NVE, Apple’s $133 billion in cash currently equates to about 23% of its market cap.
As I noted in my previous NVE article, my beef with the management team has not been their execution. Despite volatile product sales in recent years, it’s difficult to argue with NVE CEO Dan Baker’s steering of outstanding bottom-line success while at the helm. Over Baker’s tenure, NVE has spearheaded meteoric earnings growth from EPS of $.05 in 2009 to $2.29 in fiscal 2013. Nevertheless, management not only has a fiduciary duty to prudently manage the company’s operations, but it also has a duty to prudently manage the company’s capital allocation strategy, and that is where NVE is falling short. By holding $100 million in cash, NVE is being recklessly conservative.
Is there a reason management is being so stingy with their cash hoard? Even with cash tripling over the last five years ($32m to $100m) and operating margins surpassing an incomprehensibly high threshold (60%), NVE still has managed to open their wallets to pursue these costly actions:
- Double Capacity: NVE doubled their manufacturing capacity in fiscal 2013 with minimal investment ($2.8 million);
- Defend Patents: NVE fought and settled an expensive patent dispute against Motorola spinoff (Everspin) as it related to the company’s promising MRAM technology;
- R&D Expansion: The company shored up its research and development efforts, as evidenced by the +39% increase in fiscal 2014 R&D expenditures, to $3.6 million.
The massive surge in cash after these significant expenditures highlights the indefensible logic behind holding such a large cash mound. How can we put NVE’s pile of cash into perspective? Well for starters, $100 million is enough cash to pay for 110 years of CAPEX (capital expenditures), if you simply took the company’s five year spending average. Currently, the company is adding to the money mountain at a clip of $13,000,000 annually, so the amount of cash will only become more ridiculous over time, if the management team continues to sit on their hands.
To their credit, NVE dipped half of a pinky toe in the capital allocation pool in 2009 with a share repurchase program announcement. Since the share repurchase was approved, the cash on the balance sheet has more than tripled from the then $32 million level. To make matters worse, the authorization was for a meaningless amount of $2.5 million. Over a five year period since the initial announcement, the company has bought an irrelevant 0.5% of shares outstanding (or a mere 25,393 shares).
A Prudent Proposal
The math does not require a Ph.D. in rocket science. With interest rates near a generational low, management is destroying value as inflation eats away at the growing $100 million cash hoard. I believe any CFO, including NVE’s Curt Reynders, can be convinced that earning +7% on NVE shares (or +15% if earnings compound at historical rates for the next five years) is better than earning +2% in the bank. Or in other words, buying back stock by NVE would be massively accretive to EPS growth. Conceptually, if NVE