Description

Ergo Science Corp is one of the growing number of companies trading with a market cap below cash and liquidation value. Ergo has $27 million in cash or bonds, no debt, and a market cap of $11.2 million. Unlike most other companies trading below cash value, Ergo is not running substantial operating losses, and there is no entrenched management team trying to protect the salaries they are pulling down. To the contrary, Ergo is 20% controlled by a major institution, an affiliate of Citicorp, that has stopped the losses, and appears to be focused on creating value by making the company profitable. Here are the basic facts about the company:
1. Company background. Ergo went public about 5 years ago to raise money for biotech research into metabolic disorders. A couple years ago, the company’s application for approval of a diabetes drug encountered delays, requiring further expensive testing. At the same time, 2 new diabetes drugs came to market and have been successful, making the original opportunity appear less lucrative. Rather than spending its cash on further research, Ergo announced that it was evaluating the situation.
2. Balance Sheet and Income. The company has about $27 million in cash, marketable securities and long-term bonds. There is no debt. Last year, all but a couple full time employees were let go or moved to part time, so that interest income is sufficient to cover most operating expenses. There are 14.2 million shares of common. There are also preferred shares with a $9 million preference, leaving about $19 million for the common in the event of a liquidation. The company has one other valuable asset-- an $80 Net Operating Loss tax carryforward, which can be used to reduce taxes on future profits so long as there is no change in control.
3. Recent Developments. About six months ago, the Citicorp venture capital fund that owned 10% of the company bought another 10% from the last remaining large shareholder. Citicorp paid $1.60 per share, a good 50% premium over the market. Three of the five directors, most of whom had a biotech background, resigned, leaving the CEO and a Citicorp representative as the 2 directors. In January, a third director was appointed, who also has ties to one of the Citicorp venture capital funds.
4. Risk/Reward. With 2 of 3 current directors with a VC background, and the biotech directors gone, it seems likely that Ergo will use its $27 million in cash to purchase another company. The VC directors should have excellent deal flow. In this market, it is likely that a small private company can be purchased for 4-6 times earnings, or even better. If Ergo acquires a company that earns $5 million, and trades at a P/E of 8, the stock should rise to about $3. If the company acquired has decent growth prospects, and trades at a P/E of 15, the stock could trade in the $5-6 range. With the $80 million NOL, all the profits would fall to the bottom line, so that the balance sheet will continually improve. It seems to me that the major downside on this stock is that there is a liquidation, in which event you can still make a good return buying at these levels. I think there is limited downside, and the potential for returns of 3x your money or more.

Catalyst

The directors with the Citicorp venture capital affiliations, who have already acted to stop losses and preserve cash, will identify a profitable acquistion target, and the company will begin to trade a multiple of earnings rather than a discount to cash.