Trident Microsystems, Inc. (TRID)

Although Ultralong provided the spark of interest in TRID, my decision to recommend was based on the following analysis. I am viewing this as a nearly pure speculative play. The last time I selected a stock with this sort of price to cash ratio, the company decided to liquidate under several external pressures. So with that cautionary note in place, I shall proceed on the basis of a $1.68 per share price.

Trident Microsystems, Inc. (TRID) designs, develops and markets integrated circuits and associated software for digital media applications, such as digital television, liquid crystal display television and digital set-top boxes (STB). TRID also designs cross-platform software that allows multimedia applications to run on devices in the digital living room, such as digital STBs and digital television sets. As a percentage of total revenues, during fiscal 2008, the digital media segment accounted for 100% of its revenues. In March 2009, a wholly-owned subsidiary of TRID acquired the frame rate converter, demodulator and audio product lines from Micronas’ Consumer Division.    

In April 2009, TRID announced its new video processing technology, Enhanced Super Resolution (ESR). The purpose of this state-of-the-art product is to allow the high-resolution capabilities of a person’s television to improve standard-definition images with enhanced details, resulting in sharper images that appear more like high definition.

On paper, the stock looks like a reasonable value play. The EPS has been positive four of the last five years and 2006 and 2007 were TRID’s two strongest years, and while 2008 was not nearly as strong, it was still positive. Free cash flows have also been positive in the last five years, with 2006 through 2008 much stronger than any earlier years. With no debt (including the acquisitions mentioned above), TRID has a current ratio that has dropped as low as 2.98 only once in the past eight years. In addition, TRID’s cash position is nearly twice the price; that is, the company could distribute a special dividend to its shareholders equal to its price and still have nearly that amount still available in cash.

In the past year, TRID lost several key Asian customers that had turned this company from being profitable to a cash burner. TRID’s response was to purchase three product lines from Micronas Semiconductor. The purchase price was a dilution of about 7 million shares worth at the time about $10 million, and warrants for an additional 3 million shares, but the guidance on the resulting revenues are $35 million per quarter, or $140 million per year. Although not a complete recovery of the lost revenues, it did plug about 90% of the hole.

Before I look at the valuations, I look at three indicators of financial safety. For this stock, two results were cautiously safe and one was quite good. The Altman Z is 2.35; below 1.8 is risky, above 3 is the safe range. The Piotroski F is 4; 2 or below indicates caution, while 8 or 9 indicates that the stock is expected to rise within the next year. The Sloan accrual is -18.08; 5 or higher is high risk, while -5 or lower is excellent.

I use more than one valuation method to gauge intrinsic value; the first two all provide a substantial margin of safety (MOS). The first two are standards in the valuation literature. The estimate based on Graham’s formula was $21 (92% MOS). The Discounted Cash Flow estimate valued the stock at $14 (88% MOS). Other valuation methods I typically use required more than simple adjustments – so I choose not to report them here, which is part of the reason behind my beginning this recommendation by emphasizing that it is “a pure speculative play.” I did take a look at valuations using other available tools. For example, without adjusting the input data the ValuePro.com DCF valuation was $5.48 (MOS 69%). Plugging data into the BetaPeg.com spreadsheet provides 24 valuation methodologies whose estimates ranged from $0 to $12.83, with an average* valuation of $4.33. I also found one other source which reported that their long-term valuation was $15 (but did not discuss their methodology).

* To calculate an average, I dropped the three valuations that resulted in $0. These three valuations would yield meaningless results in TRID’s situation. Two were zero because TRID has no dividend, and the third was zero because TRID has no debt.

One last element to consider - let us also throw a catalyst into the mix. Spencer Capital Management, a New York based investment partnership submitted “a notice of nomination of two candidates for election at the 2009 annual meeting of Trident stockholders.” In connection with this nomination, Spencer Capital has previously announced an intention to file a proxy statement with the SEC to solicit TRID’s shareholders. Spencer Capital specializes in deep value investing and is headed by Kenneth H. Shubin Stein, M.D., C.F.A. whose investment accomplishments include founding (or co-founding) three investment L.L.C’s, being the portfolio manager for several funds, and teaches an advanced investment research course at the Columbia University Business School.

Even if Spencer Capital had not already announced plans, TRID would be a strong candidate for an activist campaign because:
•   TRID is deeply under valued. My estimation for its replication/liquidation value is about $4.28 per share which is about 2.5 times the current price. My estimate is based on Greenwald et al.’s methodology, but I have seen another’s estimate to be $2.66, which is still 1.6 times the current price, but seems too conservative given the cash position.
•   At $102 million market cap, TRID is large for a net cash stock.
•   TRID’s value is largely in cash. As mentioned above, the cash is about twice the market cap and more than 75% of the liquidation value.
•   Although there are a substantial number of shares in institutional hands (68.5%), only 1.6% are in the hands of insiders (other than Micronas Semiconductor, who owns 12.4%).
•   The average volume is about 500,000 shares per day (476K 10-day average, 544K 3-month average), which provides enough volume for an investor seeking to obtain a 5% stake to accumulate the necessary shares in a reasonably short period of time.
The annual meeting is not until November, so there is still time for a different vision than Spencer Capital’s to alter TRID’s financial course. TRID has indicated that, “to date, Spencer Capital has not communicated with us regarding any concerns they may have,” so it difficult to evaluate the possible directions the company may take.

In sum, there are several reasons to become a TRID shareholder. TRID has taken important steps on their own to improve their financial position (creating the ESR technology and obtaining the Micronas product lines). The stock is a reasonable value play with more than a modicum of safety. And there is at least one activist fund that has expressed an interest in shaping the future direction of TRID. Any of these could lead to a superior investment results, all of them working well together could be something special, but there is a distinct chance that it all falls apart, and, if that happens, the company’s cash position gives you a good chance to escape with little or no loss.