Description

Adams Golf (NASDAQ:ADGF) is a microcap golf equipment manufacturer trading at a discount to net current asset value despite strong profitability, growing revenues and market share, additional value from deferred tax assets not recognized on the balance sheet, and the potential for significant positive operating leverage going forward from the recent acquisition of a bankrupt competitor at favorable prices.

Earnings valuation and outlook

Adams designs, manufactures and distributes mid to high end golf clubs under a variety of company-owned brands including Idea Pro, Speedline, Insight, Lady Fairway, Women's Golf Unlimited, and Square 2. At just over half 2008 levels of $10, ADGF shares are available at attractive multiples to trailing and historical earnings. Beginning to recover from a sharp dropoff in consumer spending during the financial crisis, ADGF generated $0.70 per share in fully diluted ttm earnings for a P/E ratio of 7.86. Valuations to recent historical earnings are even more attractive; before the FY2008-9 downturn (which included significant one-time charges from final settlement of a 2000 class action suit), ADGF earned $1.24 and $1.32 per share in each of the 2006 and 2007 fiscal years - taking the lower of these numbers, the current multiple to historical earnings is just 4.2.

Although the stock sold off recently on a difficult comparison against year-ago earnings of $0.63 in a single quarter, an increase in marketing and R&D spending relating to launch of several new product lines in the current quarter has masked continued 15-20% growth in revenue and market share across multiple categories. Earnings also continue to be impacted by costs of a lawsuit filed by Adams against its former liability insurance broker. In June, the Circuit Court of Cook County IL granted a preliminary motion that could result in a net recovery to Adams of at least $3.75 million plus attorney's fees if allowed to stand, in addition to eliminating legal expense going forward. Simply continuing recent earnings performance should create generous returns for ADGF shareholders, while a return to anywhere near past levels of profitability could generate greater than +100% upside from current levels.

Recent opportunistic acquisition

Management appears to have a disciplined track record of capital allocation, and Adams has not been a serial acquirer. However, ADGF recently closed on a small but significant opportunistic acquisition, buying the assets of former competitor Yes! Golf at a bankruptcy auction where the company was the only bidder. Although possessing a strong brand identity for its core putter products, the firm had struggled after an aggressive and poorly timed expansion heading into the credit crisis, and working capital problems stemming from high leverage exacerbated a precipitous decline in sales. The purchase price of $1.65 million already represents a reasonable multiple to the firm's end-stage $2.4 million of sales when under extreme distress in 2010, but appears exceptionally attractive when compared to 2007 revenues of more than $10.2 million. The acquisition included significant inventory which is currently being rolled out using ADGF's existing sales channels. If Adams can leverage its existing sales, marketing and distribution infrastructure to improve margins and drive an increase in sales regaining even a fraction of prior levels, this acquisition could contribute to significant further earnings growth over the coming years, potentially leading to multiple expansion as the firm's growth becomes better recognized.
http://finance.yahoo.com/news/Adams-Golf-Acquires-Key-pz-2517033662.html?x=0&.v=1

Balance sheet

ADGF trades at 0.7 times tangible book value of $7.11 per share. Before considering tax assets, PPE, and intangible value of brands and technology, Adams' $42 million in current assets net of all liabilities exceed the $40 million market cap.  Adams also had $19.75 million in deferred tax assets as of the last 10-K, $9.5 million of which are not represented in reported book value under a valuation allowance. If recent profitability continues, recognition of deferred tax assets would bring adjusted tangible book value to more than $8 per share.

Intangibles and private market value

Adams has been experiencing continuing gains in market share that appear to be stimulated in part by perceived leadership in technological and design innovation, creating an increasingly positive brand identity that has enabled a 15.8% ROE and could lead to further improvements in market share and net margins. In January 2011, Adams products received seven awards in Golf Digest's latest annual equipment issue, and Adams' Idea Tech V3 irons were selected as one of four products to receive the Editor's Choice award. During late 2010 the company gained valuable publicity from multiple internationally televised events, with two golf pros taking home several major championships using company clubs: Bernhard Langer winning both the U.S. Senior Open and Senior British Open, and Yani Tseng winning the Women's British and Australian Opens.

Already trading at a discount to tangible book value, ADGF appears to have significant intangible brand and intellectual property assets that could have substantial additional value to an acquirer. Adams owns 51 U.S. patents regarding various golf equipment technologies, and has a further 13 patent applications pending. The firm has invested over $16 million in research and development since 2004, and its returns on equity support the existence of intangible brand and patent asset value not present in GAAP shareholders' equity. As a microcap public company, Adams could achieve very substantial per-share savings in marketing, administrative, and Sarbox compliance costs if acquired by a strategic buyer, rasing its value to such a firm significantly. Acushnet Golf (owner of the Titleist and FootJoy brands) was recently sold for approximately 1X 2010 revenues, which would equate to $12.75 per share for ADGF. Although there has been no public discussion of a potential sale, management and Board members own 46% of the common stock, nicely aligning them with shareholder interests should an attractive offer be received.

ADGF appears to be a profitable and growing business trading at a discount to tangible book value and net current assets and low valuations to current and historical earnings, with further potential upside from operating leverage relating to its recent opportunistic acquisition at bankruptcy auction. Although the float is limited, microcap value investors should enjoy strong risk-adjusted returns and a generous margin of safety.

Catalyst