Summary
- ModusLink is a $115mm TEV business with a $2BB NOL.
- Activist Steel Partner owns almost 30% of the company and is seeking an acquisition.
- Steel Partners' long-term track record is excellent, and an accretive deal could unlock substantial value for MLNK.
ModusLink (NASDAQ:MLNK) is a small-cap stock down 30% over the past year. A convert deal priced last March (paired with the requisite short sellers), and concerns over a lost customer announced in the Fall were the primary culprits. The company today however boasts a massive $2BB NOL, plus net cash of $80mm. Together these offer potentially $5.70 of value on a $3.50 stock.
But different from many shell NOL companies, MLNK actually owns a decent operating business that generated $23mm of EBITDA last year. Altogether, assuming just a 4x EBITDA multiple on the operating business, implies a valuation of over $7.00, upside of almost 100% on the stock. All the stock needs is a reasonably priced acquisition to get there.
Basics
Business
ModusLink has quite an interesting history, and many may be surprised to learn that this is the residual business of CMGI. CMGI was a famous Internet incubator (remember Altavista?), having invested in some 70 different dotcom companies in the late 1990s. At its peak, it sported a $45 billion market cap, and the founder David Wetherell was once hailed as the "Warren Buffet of the Internet." Note the word "once".
CMGI in its day created a series of funds in its @ Ventures segment, of which even today the company has $7mm of residual value on the balance sheet. Overall though, these investments were disastrous, and in total @ Ventures (among other losers) just generated huge Net Operating Losses (NOLs). Today, CMGI has been renamed MLNK after its only surviving operating business, and still owns NOLs totaling $2.0BB.
Supply chain management companies generally source raw materials for manufacturers, warehouse them until needed, and often offer light value added services like kitting and assembly. It is not exactly a great business, but it's not terrible either. MLNK can purchase components or raw materials in bulk, saving smaller customers money as well as reducing their working capital needs.
In the last fiscal year ending July 2014, ModusLink generated $23mm of EBITDA on $723mm of revenue, and spent $4mm in capex. Much of the revenue is in the form of pass-through raw material/component charges, i.e. value added revenue is a little under half of stated revenue.
MLNK has had a somewhat rocky history in the past 3-4 years. It was forced to restate financials in 2012 (which really only impacted 2010 and earlier years in a minor way). It lost some business as its biggest customer (Hewlett-Packard) has seen falling revenue while also reconfiguring its supply chain. Steel Partners (NYSE:SPLP) purchased a 27% stake in MLNK in March 2013, subsequently revamping management and the board. And finally, a convert issued last year led to arb's shorting the equity, pushing the stock down roughly 25%.
Over the long term, MLNK's business has generated stable margins (GM's around 10%), and excluding accounting charges and professional fees (mostly from the restatements in 2012 and 2013), generally throws of positive unlevered FCF.
(click to enlarge)
While margins look and are slim, it's worth noting that component purchases are often directly passed through to customers. Last year some $435mm of revenue/costs were simple pass throughs.
CEO John Boucher started in early 2013, and as is evident in the financials above, has done a good job of focusing on profitability (sometimes at the expense of revenue), and improved EBITDA margins from zero to around 3.2% last year.
Unlocking Value
Steel Partners bought its 27% stake in early 2013, agreeing not to acquire more than 30% of the company for 2 years (until March 12, 2015). They paid $4/share for 7.5mm new shares, and also received warrants to buy 2mm shares at $5 which expire in March 2018. Steel Partners' controlled Handy & Harman (NASDAQ:HNH) bought the other 6.5mm shares in the open market.
The 30% limit on ownership was likely done in order to prevent a change of control (which could limit usage of their huge NOL). Their MO is obvious: fix the core logistics business and acquire a profitable business to take advantage of its NOL position. Personally, I speculate that Steel would like to pick up another chunk of equity in MLNK, which it can do in March 2015, less than three months away. Then, an accretive acquisition could cause a huge pop in the stock. SPLP is clearly highly incented to see a stock price well above $5 in the next 3 years.
Regarding a potential deal, MLNK picked up a 10% stake in Medifast (NYSE:MED) just last quarter. With total liquidity of $150mm, perhaps more if some investments were monetized, ModusLink has plenty of dry powder, and an intelligent private equity sponsor behind them.
Upside Potential
As it is, MLNK must do an acquisition to utilize its NOL. My base case is that the company buys a private company for 7x EBITDA, not a crazy multiple at all with $150mm of cash and liquidity. That would add $21mm of EBITDA, and using a very conservative $17mm EBITDA number from the core business (down from $23mm last year), totals $38mm. The FCF in 2016 (FYE July) easily could look like:
(click to enlarge)
At 51c/share in cash earnings, the stock could trade at least at 10x FCF, and more likely at 12-14x.
That would offer a range of values of $5.13 to $7.18, upside of 42% to 99%. (I did ignore the warrants here for simplicity, but that would only dilute the upside case by approximately 4%).
Risks
The company does not have quarterly conference calls, and investors were clearly disappointed in the company's most recent results. Losing most of their Hewlett-Packard (NYSE:HPQ) business will hit revenue by $175mm next year, and will have some margin impact too. Given the level of component sales however, lots of this revenue was only marginally profitable, and just pass-through, low value added work. In any case, I have modeled EBITDA to decline by 26% to $17mm next year.
The real upside scenario is an accretive acquisition. While it's hard to gauge Steel Partners' returns today given the complexity of their financials and mix of public company stakes, the early returns in their private equity fund were impressive. Virtually every stake in public companies that Steel owns (Steel Excel, Handy & Harmon, and ModusLink for example), have in common high free cash flow characteristics. None are negative FCF after capex. From Steel Partners' website regarding potential acquisitions:
"We are interested in new industrial or aerospace/defense businesses with $25-75MM of EBITDA. We prefer companies with gross margins above 20%, high return on invested capital, sustainable competitive advantages and strong brands. We like businesses participating in structural changes where the business is positioned to gain market share. We will consider a transaction or series of transactions for up to $1B in enterprise value."
According to the Financial Times, Steel Partners generated gross annual returns of 22% from its inception in 1990 to 2007. Its mix of assets today is:
ModusLink as a top five position for Steel tells me that it is an important investment for them. CoSine is also a public shell company with a big NOL, but likely is too small for them to take notice. The risk is of course that Steel Partners overpays for an acquisition, or dilutes holders in order to do so.
As far as comparables go, it's hard to come up with good peers. Some NOL shells can go years without an activist or team to create value via a deal, but in this case MLNK is actively looking, and probably has to consummate something in the next year or two in order to create value for their warrants by 2018. But it is a risk that SPLP won't find a suitable target for MLNK, and the NOL sits unused.
Conclusion
As far as downside goes, I value the NOL at zero, and the business at 4x next year's $17mm EBITDA, and add the cash. That would net an investor $2.85/share. That happens to also be pretty close to the lowest the stock has traded over the past 5 years. On the plus side, just a year ago MLNK almost traded to $6, so the upside case seems quite achievable. That is $0.75 down, and $3.50 up, for a 4.6:1 risk reward ratio.
Finally, it is worth mentioning that this idea is not terribly correlated with the market. In fact, a falling equity market may create an acquisition opportunity at a more attractive price for MLNK. Given the difficulty of finding ideas in this tape, and potential for higher rates to push down stocks in 2015, MLNK seems a good non-market correlated place to park some cash.
By Thomas Lott
Source:http://seekingalpha.com/article/2775125-why-moduslink-global-could-be-a-double 
I think that it is worth mentioning that this idea is not terribly correlated with the market. In fact, a falling equity market may create an acquisition opportunity at a more attractive price.
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