Description

DGT Holdings Corp. (DGTC) is a severely mispriced company with no remaining operations (and no remaining direct employees) as it is now finalizing a stealth liquidation process, creating what essentially is now a cash, real estate and NOL rich shell trading at a 40%+ discount to its net asset value with upside potential to NAV of nearly 80%.  Owing to its income stream from two real estate leases, there is no meaningful ongoing cash burn.  As such, this investment has negligible downside risk and I expect full value to be realized over the next 3 to 12 months as the likely transactions described herein occur, driven by DGTC's controlling shareholder which has been aggressively purchasing additional shares. 

Purchase DGTC for $10.75 and receive the following, which in total approximate $19.34 per fully diluted share:

1. Cash and marketable securities, net of all actual, estimated and potential (escrowed) liabilities (excluding the mortgage note , of $14.23 per share.  This includes 97,549 shares of Handy & Harman Ltd. (Nasdaq: HNH) purchased directly by DGTC in the open market between May 23^rd and August 20^th, when the insider window closed.  This is one key to the thesis, as explained below.
2. Escrow cash, a portion or all of which is likely to be returned, of $0.38 per share.
3. A 55,000 s.f. corporate office and manufacturing facility based in Bay Shore, NY (Long Island) and a 67,000 s.f. design and manufacturing facility in Milan, Italy with an aggregate liquidation value, net of a small mortgage on the Bay Shore facility, of approximately $2.35 per share.  Both of these properties are very well located, have long term leases in place and will clearly be sold.
4. Federal NOLs, which I estimate at $37mm, and which expire at various times between 2020 and 2030, that have an estimated PV of $2.38 per share.  Note that as of the most recent 10-K this amount was $52mm, although I estimate from Company disclosures that $15mm of that amount has been applied to gains from recent asset sales.
5. State Tax Credits and NOLs of $2.1mm to which I assign no value for simplicity’s sake.

Activist / Controlling Shareholder

In addition, you receive a well-known activist investor working for you in the form of Steel Partners Holdings L.P. (NYSE: SPLP), which owns 52% of the outstanding stock and is controlled, of course, by Warren Lichtenstein as Chairman.  SPLP president Jack Howard is the Chairman of DGTC and Steel Partners Managing Director and Operating Partner John Quicke has been the CEO of DGTC since 2009.  SPLP has a weighted average cost basis of approximately $8.25 in DGTC shares.  As a hybrid hedge/private equity fund, the general partner of SPLP is entitled to receive Class B Common Units in SPLP equal to 15% of the increase in that company’s equity value as of year-end.  Therefore, there is clear incentive for the GP to maximize value here and across its portfolio, and to do so in the next four months.

Insider Purchases

SPLP has recently purchased the majority of the stock that has come available in the open market while the insider window was open from July 2^nd to July 23^rd.  This stock was acquired at prices ranging from $10.65 to $11.00.  The insider buying window is now closed for SPLP and I expect it will reopen on Tuesday, as DGTC released preliminary Q4 earnings yesterday (August 29^th).  In fact, I am virtually certain that they released earnings early to allow them to resume buying stock without delay (there is no other reason to have pre-released). 

Management / Employees

Importantly, now that the RFI division has been sold, there are no remaining employees on DGTC’s payroll.  The CEO John Quicke is an operating partner with Steel Partners and the CFO of DGTC is the full-time CFO of Steel Excel (OTCPK: SXCL).  They operate a “virtual office” as the CEO and CFO work remotely and travel frequently.  There is not even a DGTC secretary, as SPLP is highly cost conscious, and the formal DGTC mailing address is now SPLP’s NYC office.  The sole remaining expenses at DGTC consist of board fees (~$20k cash per outside director), audit fees (~$248k for 2011), filing fees and ancillary expenses.  The remaining cash costs are almost entirely offset by the ~$815,000 of annual real estate rental income DGTC receives, so there is minimal, if any, net cash burn.

Why Does The Opportunity Exist?

1. Illiquid micro-cap stock traded on the OTCBB.
2. No analyst coverage.
3. No conference calls, conferences or investor presentations.
4. Press releases have contained bare minimum information, no statement that the Company has no remaining business operations or statement of future plans, beyond the CEO’s statement in the Q3 earnings release that “We continue to actively monitor ways to create shareholder value.”  There was no CEO quote in yesterday’s preliminary Q4 release.
5. Last reported balance sheet does not reflect the closing of the sale of its RFI Power Conversion business, so cash is understated and a clear financial picture is not readily available to those not doing the work.  As the RFI sale closed on August 16^th, the cash is not reflected on the preliminary Q4 balance sheet either, as the FY ended July 31^st.
6. Those who are aware of DGTC are likely just looking at cash, and have not pieced together the substantial real estate and NOL value.
7. Nobody noticing the significance of the large direct purchases of HNH shares by DGTC.

Recent History

DGTC’s pro forma cash balance is largely the result of four transactions over the past two years, which have in total eliminated all of the Company’s operating business, converting DGTC into a rent-collecting landlord over two valuable properties with large balances of both cash, marketable securities and NOLs:

1. On August 16, 2012, the Company sold its RFI Power Conversion business to Ultra Electronics Defense, Inc. for $12.5mm, payable in cash.  At closing, $1.25mm of these proceeds were held in escrow to serve as indemnification security and $0.24mm were held in escrow to cover any potential net working capital adjustment, which settle 18 months after closing.  As part of the transaction, the Company retained the real estate and 55,000 s.f. building in Bay Shore, NY (Long Island) that houses RFI’s operations and entered into a lease with the buyer providing for $396,000 of annual rent, payable monthly.
2. On November 3, 2011, the Company sold Villa Sistemi Medicali S.p.A. (“Villa”) for cash consideration totaling $27mm.  As part of the transaction, the Company retained the real estate and 67,000 s.f. building in Milan, Italy that houses Villa’s operations and entered into a lease with an initial term of 6 years with €335,000 annual rent, payable quarterly.  The real estate is discussed further below.  In addition, DGTC received a €500,000 promissory note for which principal is reduced to €400,000 if prepaid in full within 18 months of the closing date.
3. On December 22, 2010, the Company raised $15mm in a rights offering.  It is this rights offering, which was only 65% subscribed by existing holders, that allowed SPLP to gain control of DGTC via exercise of its oversubscription rights.
4. On September 1, 2010, the Company completed a 10-year 4.9% mortgage on its Bay Shore, NY property that generated $2.5mm of cash proceeds.

Pro Forma Balance Sheet

Real Estate

The following links provide additional visual data regarding the Company’s owned properties:

• Map:  http://goo.gl/maps/gfJqs
• Street View:  http://goo.gl/maps/GSVQH
• Comps in Bay Shore, NY (provided by LoopNet): 

        

• Map:  http://goo.gl/maps/N3XgG
• Street View:  http://goo.gl/maps/jKRZf

Background On Handy & Harman Ltd. (Nasdaq: HNH, www.handyharman.com)

HNH, the company whose shares DGTC has recently been purchasing aggressively, is also majority owned and controlled by SPLP, which presently holds a 55% ownership stake.  The Capital IQ description is as follows: 

Handy & Harman Ltd. engages in precious metals, tubing, and engineered materials businesses in the United States and internationally. Its Precious Metal segment fabricates precious metals and their alloys into brazing alloys, including gold, silver, palladium, copper, nickel, aluminum, and tin for use in electrical, appliance, transportation, and construction industries. The company’s Tubing segment provides seamless stainless steel tubing coils for petrochemical infrastructure and shipbuilding markets; and welded carbon steel tubing products for consumer and commercial refrigeration, automotive, and oil and gas industries, as well as for the heating, ventilation, and cooling industry. Handy & Harman Ltd.’s Engineered Materials segment offers fasteners and fastening systems for construction and building industries; plastic and steel fittings and connectors for natural gas, propane, and water distribution service lines; exothermic welding products for electrical grounding, cathodic protection, and lightning protection; and electro-galvanized and painted cold rolled sheet steel products for construction, entry door, container, and appliance industries. The company’s Arlon Electronic Materials segment provides performance materials and circuit substrate laminate materials for the printed circuit board industry; and silicone rubber-based insulation materials for industrial, military/aerospace, consumer, and commercial markets. Handy & Harman Ltd.’s Kasco Blades and Route Repair Services segment offers meat-room blade products, repair services, and resale products for the meat and fish industry, as well as to distributors of electrical saws and cutting equipment; and wood cutting blade products for pallet manufacture and recycle, and portable saw mill industries. The company was formerly known as WHX Corporation and changed its name to Handy & Harman Ltd. in January 2011. Handy & Harman Ltd. was founded in 1852 and is based in White Plains, New York.

For the year ended December 31, 2012, HNH management has guided to sales ranging from $635-776mm and Adjusted EBITDA ranging from $77-94mm. 

To add to the interwoven nature of these entities, HNH also directly owns 5.9mm shares of ModusLink (Nasdaq: MLNK), which it purchased at an average price of $4.10, giving it a 13.7% ownership stake in that company.  Steel Partners (the hedge fund, not the publicly traded SPLP), owns 6.5mm shares of MLNK representing a 15.0% stake.  While MLNK now trades for only $3.21 and HNH has an unrealized 22% loss at present, this is a “hidden asset” on the HNH balance sheet. 

With a current market cap of $185mm, total debt of $155mm, MLNK shares worth $19mm and cash of $6mm, HNH has a TEV of $314mm.  This implies a valuation of 3.7x Adjusted EBITDA at the midpoint of guidance.  Using 100% of LTM capex of $15mm, HNH trades for 4.5x EBITDA-Capex.  Net debt to Adjusted EBITDA is a modest 1.75x (excluding MLNK shares) at these levels.

While HNH has an unfunded pension liability of $186mm, so taking a draconian approach and including the full amount of this liability would add 2.2 turns to the valuations in the preceding paragraph, leaving a still cheap stock (it is not clear whether cash contributions to the pension are running through the P&L or cash flow statement).

Finally, HNH is a cash taxpayer and therefore would benefit from the $183mm of Federal NOLs ($64mm tax-effected), which expire between 2018 and 2029.  These NOLs are not subject to Section 382 annual limitation due to the company’s emergence from bankruptcy in 2005.  The $183mm includes a reduction of $31mm in respect of interest expense paid to creditors who became stockholders as a result of the reorganization.

How Will Value Be Realized?

Based on the data presented above, I strongly believe that one or more of the following events will occur in the near future, thereby realizing full value in DGTC shares:

• It is also possible, but far less likely in my view, that DGTC acquires and merges into HNH, leaving HNH as the surviving entity.  However, such a transaction would be less certain to close as HNH has far more sophisticated shareholders, making valuation, structure and approval unnecessarily complex.

Risks

While I believe the risks here are negligible given the valuation and that Steel’s incentives are aligned with shareholders, there is always some risk that a transaction occurs that does not achieve full value for DGTC shares.  That said, as both DGTC and HNH are both majority owned by SPLP, and given the simplicity of DGTC's pro forma balance sheet, independent directors and fairness opinions should provide protection to ensure value is realized. 

Disclaimer:  The author of this idea presently has a long position in securities of this issuer and may trade in and out of these positions without notice.  The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates.  No representation or warranty is made as to the accuracy of the data or opinions contained herein.

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