Value Find: ESS Technology, Inc.
After pressure last year from activist investors, this beaten-down microcap technology company is finally showing signs of getting its act together.
Last May, investment firm Riley Investment Management publicly expressed its displeasure with the financial performance of long-struggling, fabless semiconductor firm ESS Technology, Inc. (Nasdaq: ESST). ESS designs and markets high-performance, digital video processors for the consumer electronics market. As of last June, Riley had amassed a nearly 7% stake in ESS and demanded that the money-losing Fremont, Calif.-based company shut down its remaining chip operations, sell its investment and real estate assets, and return all proceeds to shareholders. At the time, the activist investor had estimated that ESS could be worth over $2.50 a share under a liquidation scenario, although the estimate didn’t seem to include shutdown expenses.
ESS responded to the pressure from Riley and Loeb Partners, another major shareholder, by disclosing that it had formed a special committee in April 2007 to consider strategic alternatives, including a potential liquidation. ESS also reminded shareholders that, since November 2006, it had sold its advanced BlueRay/HD-DVD technology for $13.5 million, licensed its standard definition DVD products for $2 million plus future royalties and had closed its unprofitable camera phone division. This response didn’t satisfy Riley and, in mid-July of last year, it nominated four Riley representatives for election to ESS’s board of directors at its next annual meeting. Less than a month later, ESS co-founder Fred Chan resigned as ESS’s chairman.
Fast forwarding to this past fall, ESS, with a $44 million market capitalization, announced in late October that it had signed an agreement to sell its real estate for $26.3 million in cash. Then, at the end of November, ESS quietly disclosed in an 8-K filing that the deal had fallen through and that it was attempting to renegotiate the price. Around this same time, Riley disclosed that it had begun to reduce its stake in ESS. The combination of Riley’s seemingly reduced interest in the stock, combined with the botched real estate deal, clearly weighed on the stock. After trading over the $1.60 a share level at the start of November, ESS ended 2007 at the $1.33 level. So far, it has been more of the same for ESS, with the stock fetching just $1.20 at Monday’s close.
The lack of renewed interest in ESS in recent months is understandable, as the company has basically done nothing but rack up losses over the past few years. However, at current depressed price levels, the debt-free company now trades for basically its cash on hand and seems close to reaching an inflection point on whether it will liquidate or not. ESS ended October, its most recently reported quarter, with $47.5 million in cash in the bank. On Jan. 9, ESS received notice from the Nasdaq that it is subject to delisting for having not yet held its 2007 annual meeting and solicited proxies. ESS blamed the delay on deciding to wait until after it had completed its strategic alternatives review process before holding its next annual meeting. ESS is appealing the ruling and its shares will remain listed on the Nasdaq at least through the appeal.
For the fiscal third quarter ended Sept. 30, ESS reported decent top- and bottom-line results. Revenue checked in at $17.7 million, down from $23.2 million a year ago, but up sequentially from $17.2 million. GAAP loss was $0.1 million, or breakeven per share, compared with a year-ago loss of $4.4 million, or $0.11 a share. For the fiscal second quarter, ESS reported a GAAP loss of $0.7 million, or $0.02 a share. Included in the second-quarter results was a one-time gain of $2 million. ESS delivered a non-GAAP operating profit for the third quarter of $0.6 million, or $0.02 a share. According to ESS CEO Robert Blair, this was the first time ESS had returned to operating profitability “in many quarters.” For the fiscal fourth quarter ended Dec. 31, ESS guided for revenue of $16 million to $19 million and non-GAAP net income of breakeven to $0.04 a share.
ESS is projected to report its fiscal fourth-quarter results on Wednesday, Feb. 6. On its last earnings conference call, ESS CEO Blair said that he expected the strategic alternatives review process to be completed by February. Even if ESS doesn’t decide to liquidate, an announcement from the company should help bring clarity to the situation. The commercial real estate market has clearly weakened in recent months, but a deal to sell ESS’s real estate at a reduced price should still be able to get done. Even trading for its cash on hand, ESS isn’t without its risks, but at the $1.25 level and below, this looks like a speculative grab bag of value.
Said another way, ESST is a speculative microcap “value find” worth placing on the radar.
About the Author
Contributing author Matt Ragas is an investment writer and analyst with ten years of experience analyzing small and microcap stocks, with a particular emphasis on value and turnaround situations.
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