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    Cash is king

    In these uncertain times, look for stocks trading at a discount to the amount of cash they have.
    June 11, 2002: 4:45 PM EDT
    By Paul R. La Monica, CNN/Money Staff Writer

    NEW YORK (CNN/Money) - Investors are worried sick. The war, the accounting scandals -- any attempt at a market rebound is quickly squashed as a result.

    As always, excessive pessimism creates opportunity for long-term investors. Still, there will be probably be more volatility in the short-term and nobody wants to get stuck with a stock that plunges 20 percent in a single day.

    Having what legendary value investor Ben Graham called a margin of safety can help.

    One way to attain this sense of security is to look for companies that are being valued at less than the amount of cash they have in the bank. John Buckingham, manager of the Al Frank Fund says he looks for companies that are trading below net cash value -- the amount of cash on the balance sheet minus any debt.

    Think about what net cash means: If the company shut its doors today and disseminated all its cash to shareholders, the cash per share would be worth more than the actual stock price.

    To be sure, most companies that trade at a discount to their net cash value are small and troubled. And many will spend down all their savings, making them hardly a good value at all.

    But a select group will use their cash to turn into profitable enterprises, and are now simply being mispriced by this unforgiving market -- that's what has so-called "deep value" investors salivating.

    "With these types of stocks, you have some time for the business to turn around or for management to realize it's not viable and liquidate the company and disseminate the cash to shareholders or even to find a buyer," says Buckingham.

    Deep value in technology and biotech
    There is no shortage of success stories. Take SignalSoft (SGSF: Research, Estimates), a software company that in late May had a market value of $26.8 million, no debt and $48.4 million in cash. Its stock price was $1.06. On May 29, wireless infrastructure software company Openwave (OPWV: Research, Estimates) announced it was buying SignalSoft for $2.26 a share, a 113 percent premium.

    A similar scenario took place on Monday with Web software developer SilverStream Software (SSSW: Research, Estimates). As of Friday, the company had $118 million in cash and no debt, yet its market value was just $117 million. The stock traded at $5.14. On Monday, Novell (NOVL: Research, Estimates) agreed to buy SilverStream in a deal valuing the company at $212 million, or $9 a share, a 75 percent premium. Buckingham owns SilverStream in his fund.

    The telecom and tech meltdown of the past two years has actually created a host of similar value plays.

    "We have a much higher weighting in technology now than we did in the beginning of 2000. We play in areas where there is negativity," says Scott Barbee, manager of the Aegis Value Fund. Barbee owns SignalSoft, for example.

    Another tech company that Barbee owns that he wouldn't have touched during the tech bull market is Liquid Audio (LQID: Research, Estimates), a company that makes encryption software for digital music on the Internet. The stock traded as high as $49.25 following its initial public offering in 1999 but now trades at $2.55. Its market value is $58 million.

    Still, the company has $86.4 million in cash and just $400,000 in debt. What's more, Barbee thinks there is a good chance that the company will sell out since Steel Partners II, a private equity fund that owns 9 percent of the company is pressuring Liquid Audio to do so. "There's enough tree shaking going on. This is not going to be a situation that persists," Barbee says.

    Among his top tech holdings, Buckingham mentions optical networking equipment companies Avici Systems (AVCI: Research, Estimates) (market value of $70.4 million, net cash value of $114 million) and Cosine Communications (COSN: Research, Estimates) (market value of $57.8 million, net cash value of $142.1 million); Web benchmarking and testing firm Keynote Systems (KEYN: Research, Estimates) (market value of $237 million, net cash value of $246.4 million); and wireless infrastructure developer Aether Systems (AETH: Research, Estimates) (market value of $127.2 million, net cash value of $169.3 million).

    Tech is not the only area of the market that has its share of cash bargains. Michael Yellen, manager of the AIM Global Health Care Fund, says that there are even some deep value plays in one of the more inherently volatile market sectors: biotech.

    One in particular he notes is Praecis (PRCS: Research, Estimates), a small biotech that is working with Amgen on a drug called Plenaxis to treat prostate cancer. Although the drug was rejected by the Food and Drug Administration last June, the two companies have continued to test the drug with the hopes of eventually getting it approved. As a result of the FDA denial, Praecis's market value is now only $152.6 million even though the company has $256.9 million in cash and just $33 million in debt.

    What's more, the company only burned through $33.4 million in cash in the past twelve months so Yellen is not concerned about Praecis running out of funds any time soon.

    "Any change in sentiment for biotech and you could get a big move on the stock with not much risk," says Yellen.

    Buckingham owns a biotech stock in his portfolio as well: Zonagen (ZONA: Research, Estimates), a company working on an erectile dysfunction drug called Vasomax. The company has also had some difficulties in clinical trials and the drug has yet to be approved. But Buckingham thinks any more bad news is priced into the stock since it has a market value of just $17.1 million even though the company has $29.1 million in cash and no debt.

    Of course, not all companies trading below net cash value are going to get scooped up for fat premiums like SignalSoft and SilverStream Software. Even though these companies do not have the burdensome debt loads that have toppled the likes of Enron and Global Crossing, these are still small companies with limited resources. That's why Buckingham says investors looking for these deep values need to buy a basket of these stocks. The one or two home runs can compensate for losses in the others.

    "When you make 400 or 500 percent on some of these you can afford to sit there with some stocks that haven't performed well," Buckingham says.

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