Description

Peerless Systems (PRLS) is a simple idea with a complex story. PRLS sold off most of its business last year and is essentially a pile of cash looking for something to do. They receive a residual bit of IP licensing and
interest from the cash, so there is no cash burn. If you take cash & securities and assume zero for the other assets, subtract ALL liabilities, it sells at over a 15% discount to liquidation. It is a classic net-net.

There are 16.4 million shares outstanding for a $37.5 million market cap. Current assets as of 4/30/09 were $51.8 million, of which $47.6 million consisted of cash and marketable securities, and total liabilities were $2.6 million. There are 743K stock options outstanding with a weighted average strike price of $2.23.

The complexities have two parts. First, a hedge fund called Bandera Partners bought a 21% stake in PRLS. They threatened a proxy fight and were able to get two seats on the board of directors in exchange for voting with the majority of the board. Bandera originally filed a 13G in October 2008, so they probably started buying at the October lows. Looking at the volume and prices for that month, an estimated average purchase price would be in the $1.60 to $1.70 range. Subsequent buying averaged around $1.80. I know very little about Bandera. They have filed one other Form 13D, plus a Form 13G. I am hesitant to call them an activist fund, but they are locked and loaded into PRLS.

The second part involves an investment PRLS started making this year in Highbury Financial (HBRF.OB). They own about 2.5 million shares of common and 0.5 million warrants struck @ $5 expiring in January 2010. HBRF.OB last traded at $5.01. By my calculations, PRLS should show an unrealized gain of $1.7 million as of 7/30/09 and $2.6 million as of today.  They run on an odd fiscal year, as the last 10Q was as of 4/30/09. So PRLS is probably trading at a greater discount to its real value.

Highbury is a complex situation. They own Aston Asset Management, which manages $5.1 billion in mutual funds. Highbury was a blank check company that began in 2005. They had acquired most of Aston but did not complete buying until this month by exchanging the minority interest for a convertible preferred issue. Aston is now wholly owned by Highbury and the agreement between the two entitles Highbury to 28% of Aston's revenues off the top. More discussion will follow on this.

The capital structure for Highbury is 9.1 million common shares,  a series of convertible preferred that is equivalent to  4.5 million common shares @ $5, and 10.6 million warrants struck @ $5 that expire January 2010. There were originally 13.4 million warrants but Highbury bought back 2.8 million of warrants in July 2009. The warrants were bought back at a price of $0.50, more than twice the price for which they were trading.  This prompted some shareholders to cry foul.

Assuming that Highbury continues to trade over $5 and the warrants and converts are exercised, there will be 24.2 million shares outstanding and they will receive $53 million from the warrants. PRLS would own 3 million shares or 12.5% of fully-diluted Highbury with a minimum market cap of $121 million. Note that PRLS would have to use $3 million of its cash to exercise the remaining warrants (It exercised 1,089,658 last week). Highbury would likely use the cash for acquisitions. If you look at their recent presentation:

http://www.sec.gov/Archives/edgar/data/1335249/000114420409041830/v156985_ex99-1.pdf

...you will see that that they attempt to act like a Berkshire Hathaway of mutual funds. The acquired funds retain much of their structure, brand and operations. There is no attempt to consolidate operations. Highbury provides permanent capital in return for a percentage of the revenues. The management of the acquired fund can manage the remaining revenue as it wishes, so they are incented to keep costs in line.

There is some concern about what is happening at Highbury. You can read the letter in the 13D filed by PRLS:

http://www.sec.gov/Archives/edgar/data/897893/000114420409038998/v155647_sc13da.htm

A 13D and letter were filed by North Star Investment Management:

http://www.sec.gov/Archives/edgar/data/1335249/000134285709000036/q.txt

A 13D was filed by Talon Asset Management:

http://www.sec.gov/Archives/edgar/data/1007614/000119312509137479/dsc13d.htm

Others filing 13G's are Fairview Capital and Second Curve.

Timing/Catalyst:  The last annual meeting for Highbury was in December 2008, with proxies being mailed out in October. Couple that with the January expiration of the warrants, and the next four months should be interesting.  Proposals for the next annual meeting must be received by Highbury between 9/9/09 and 10/9/09. Peerless has sent a letter to Highbury asking that one of their directors, Timothy Grog, be nominated for a board seat and that Highbury eliminate its staggered board of directors and nix a rights offering defense:

http://www.sec.gov/Archives/edgar/data/897893/000114420409048296/v160392_sc13da.htm

Value of Highbury:  If you factor in the preferreds, EV/AUM is exactly 1.0%. It is cheap, but not stupid cheap, otherwise you'd be better off in Highbury.  Since Peerless owns 1.6 million warrants, if the Highbury dissidents win, there is upside to the warrants.

PRLS is like a SPAC but without a put back feature: There is definitely a risk that PRLS does something stupid with the remaining cash. However, my goal with net-nets is to assemble a basket of small, speculative positions. A couple will probably be dogs, some will stagnate and a few will be home runs.

Catalyst

It's a net-net.