Description

Investors would realize 99% appreciation, if Peerless Systems (PRLS, $1.54) trades up to its cash position.   Peerless Systems trades below cash having $55 million in cash, a $10 million NOL and no debt, yet only has a $28 million market cap.  While this Graham-Dodd traditional net-net should liquidate, it does have an experienced board of directors focused on the Digital Content marketplace and a board created to maximize shareholder value. The board controls approximately 5% of the stock.   The Company recently sold off its legacy business to Kyocera, and announced it was pursuing a high-growth acquisition. I believe that shareholders would be better served by liquidating the business and receiving the resulting cash dividend.  The board has said publically that they will end the M&A process if they can’t find a suitable acquisition by year end.

The Company trades at a significant discount to cash, which signifies the market’s dissatisfaction with the Board’s intent to acquire another company.  Interest on its cash balance should cover most of its current operating cash burn.  In the latest quarter, the company’s operations burned $500,000 of cash.  The company’s cash is invested in money market mutual funds at JP Morgan, Bank of America and Wells Fargo.  They currently yield in the neighborhood of 3%, which should mostly cover the operating cash burn as costs come down.  PRLS has retained the rights from Kyocera to continue to use the protocol to service new and existing digital imaging customers from its legacy business.  They also have licenses from Adobe and Novell.

The current operations of the Company encompass licensing legacy technology and working with existing OEM customers.  Revenue from this is lumpy, providing $300K in Q1 and $750K in Q2.  PRLS still has 30,000 square feet of office space in LA that they are attempting to sublet.  The lease costs $60K per month and they are working with the landlord to offset the remaining liability which runs through 2012.  It is partially offset by a build-out allowance that the Company didn’t fully utilize.  According to management the lease is at current market and there are potential sub-lessors for the space.  Management has also said that they are continuing to reduce employment at PRLS.

Currently the company is focusing on new growth strategies.  Management has indicated they are pursuing acquisitions in nearly any industry except Insurance and Exploration and Production of gas and oil.  We believe that the market has spoken via the share price and has voted that this team should return the cash to shareholders who can make the decision where to invest the proceeds.

PRLS has hired an investment bank, Roth Capital Partners, to help them explore acquisition opportunities.  Its Board has significant capital markets experience.  To date, the company preformed its due diligence process on one announced acquisition candidate, Prism software.  The company backed out of this acquisition given that closing conditions weren’t met, without any penalty.  This gives us some comfort that if there is an acquisition the Board is aware of its fiscal responsibility. There has been no new information on any targets since then.

In today’s tight credit markets, companies are obviously hindered by a lack of access to capital.  I believe this benefits a cash rich acquirer, specifically Peerless, as its balance sheet provides the financing to acquire companies where others cannot obtain financing.  Thus, they should be able to buy any acquisition target with less competition, rendering a more favorable acquisition multiple for PRLS.  I am not suggesting that I believe that a purchase of an operating company is the right move.  I do believe that it gives current investors an inflection point to make a decision whether they want to own the stock.  Also, there is a probability that a purchase may require a shareholder vote, which would give shareholders the ability to decide for themselves whether an acquisition is the proper transaction for PRLS’ cash.

The last scenario I can think of is that no acquisition is identified.  Therefore the Company would institute a special dividend to essentially distribute the cash to existing shareholders and leaving a shell for a future reverse merger style transaction.

The Company has Re-aligned its Board of Directors with four members, eliminating 3 previous directors.  The new board was designed to align the board with shareholders’ interests and maximize shareholder value.  From public filings, we see that Tim Brog (Chairman) owns 128,000 shares of the stock, which he has bought in the open market over the last few weeks.  Richard Roll (CEO and Pres.) owns 2.1%.   Bloomberg shows S. Bathgate owning 1.98% with additional stakes through trusts etc, and Steven Pully has ownership of 30,000 options at a $2.13 strike.  These four control about 5% of the company’s stock.   Further, stock appreciation is clearly beneficial to them also.

Below are the Directors profiles taken from the company’s website.

Timothy E. Brog, Chairman of the Board,  has served the Company as a director since July 9, 2007, as acting Chairman of the Board from July 9, 2007 to September 20, 2007, and as Chairman of the Board since June 12, 2008. Mr. Brog has been a Managing Director of The Edward Andrews Group Inc., a boutique investment bank since 1996. From 1989 to 1995, Mr. Brog was a corporate finance and mergers and acquisition associate with the law firm of Skadden, Arps, Slate, Meagher & Flom LLP. Mr. Brog received a Juris Doctorate from Fordham University School of Law in 1989 and a BA from Tufts University in 1986. Mr. Brog is a director of The Topps Company, Inc., a company that markets premium confectionery brands and other branded products, including trading cards.

Richard L. Roll, CEO and President,  was appointed as a director of the Company, effective April 17, 2007. Mr. Roll has served the Company as our President and Chief Executive Officer since December 15, 2006. From 2003 to 2005, Mr. Roll was Chief Executive Officer of FieldCentrix Inc., an enterprise software company focused on field-service automation solutions. He operated Roll Enterprises, a management consulting firm focused on the software industry, from 2002 to 2003. From 1999 to 2001, Mr. Roll was President and Chief Operating Officer of Epicor Software Corporation, an enterprise software company specializing in integrated e-business solutions. His background in the imaging industry includes four years with Hitachi Koki Imaging Solutions, Inc. (HKIS), formerly Dataproducts Corporation. Mr. Roll was President and Chief Executive Officer of HKIS from 1998 to 1999, and successfully transitioned the divisional printer manufacturer into a worldwide imaging solutions company. He also spent more than 20 years with Unisys Corporation. Mr. Roll holds a Bachelor of Science degree from the University of Arizona and completed the Wharton Business School's Executive Training program in conjunction with Unisys.

Steven M. Bathgate, Director, was appointed as a director of the Company, effective May 22, 2008. From 1996 to the present, Mr. Bathgate has been Senior Managing Partner of Bathgate Capital Partners LLC (“BCP”), formerly known as Bathgate McColley Capital Group LLC, a FINRA-licensed Broker Dealer. Prior to starting BCP, he was the Chairman and Chief Executive Officer of Cohig & Associates, Inc., an NASD member firm specializing in public and private financing for emerging growth companies. His other previous experience includes employment by Wall Street West, Dain Bosworth, Inc., and the National Association of Securities Dealers, Inc. He received his B.S. degree in Finance from the University of Colorado.

Steven J. Pully, Director,  Mr. Pully is a consultant, working primarily in the asset management industry. From December 2001 to October 2007, Mr. Pully worked for Newcastle Capital Management, L.P, an investment partnership, where he served as president from January 2003 through October 2007. He also served as chief executive officer of New Century Equity Holdings Corp. from June 2004 through October of 2007 and remains a director of that company. Prior to joining Newcastle Capital Management, from 2000 to 2001, Mr. Pully served as a managing director in the investment banking department of Banc of America Securities, Inc. and from 1997 to 2000 he was a member of the investment banking department of Bear Stearns where he became a senior managing director in 1999. Mr. Pully is licensed as an attorney and CPA in the state of Texas and is also a CFA charter holder. He holds a B.S. with honors in Accounting from Georgetown University and a J.D. degree from The University of Texas.

Basically this is a simple story.  The stock is trading well below cash, with an experienced board of directors, focusing on an acquisition, which has been aligned with shareholders’ interests.  The more shareholders that believe that liquidation is in the best interests of the Company, the more likely that scenario becomes.

Risks:

First and foremost is the acquisition of a company that shareholders believe is not in their best interests. 

Second is the company burning cash while pursuing acquisitions and never completing a meaningful acquisition.  This is mitigated by the board’s current actions and statements.

Catalyst