Value Find: ITEX Corporation

Matt Ragas | Apr 15, 2008 6:20am EDT | 1 Comment

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Quietly profitable microcap tech stock ITEX Corporation (OTCBB:ITEX) has recently received some much-deserved attention from an up-and-coming activist value investor.

Tiny $16-million market capitalization ITEX has spent the past few years quietly plugging away at building the largest online marketplace for cashless business transactions in North America. ITEX’s business services and payment systems enable roughly 24,000 member businesses to trade goods and services valued at more than $270 million without exchanging cash. Much like eBay Inc. (Nasdaq:EBAY), ITEX generates revenue by charging percentage-based transaction fees on members’ purchases and sales using its system. ITEX also charges association fees.

A combination of acquisitions, cost-cutting and organic growth has helped ITEX post increased operating income every year since fiscal 2004. For fiscal 2007, Bellevue, Wash.-based ITEX posted revenue of $14.2 million and operating income of $1.5 million. Cash flow from operations topped $2 million. Over the past four years, ITEX shares have gained an impressive 350%, yet the stock still looks inexpensive by almost any valuation measure. Perhaps not surprisingly then, ITEX has become a recent object of affection for activist value investor Sardar Biglari of the Lion Fund. Last December, Western Sizzlin Corporation (Nasdaq:WEST), a small-cap restaurant company turned investment holding company for Biglari, announced an exchange offer for all outstanding shares of ITEX. The exchange ratio was 0.006623 shares of Western for each outstanding share of ITEX. This stock swap initially valued ITEX at $1.02 a share.

Since this initial offer, $37-million market capitalization Western has amended and extended the date of the exchange offer several times. The latest amended offer is for up to 2.7 million shares of ITEX at the same exchange ratio, scheduled to expire on April 30. As of March 26, only 905,309 ITEX shares, or roughly 5% of ITEX’s shares outstanding, had been tendered into the exchange offer. For all intents and purposes, the vast majority of ITEX shareholders have ignored this offer. ITEX’s board of directors continues to call the Western offer “wholly inadequate,” arguing that the future value of Western shares is highly uncertain and that its stock is highly illiquid. It’s hard to disagree with ITEX’s take. Western and Biglari appear to be trying to scarf up ITEX on the cheap without providing the certainty of cash.

As things stand currently, ITEX is doing just fine on its own. For the fiscal second quarter ended Jan. 31, ITEX’s revenue rose 14% to $4.18 million. For the first six months of the fiscal year, revenue increased 8% to $8 million. Net cash provided by operating activities for the second quarter increased 141% to $1.01 million. Income from operations, before depreciation and amortization, checked in at $0.63 million, or $0.04 a share, compared with $0.6 million, or $0.03 a share, a year ago. Net income of $0.31 million, or $0.02 a share, dipped slightly from net income of $0.34 million, or $0.02 a share, a year ago. ITEX ended the quarter with $1.09 million in cash on hand, $1.2 million in notes receivable and $0.87 million in notes payable.

While we may not be fans of Biglari’s cheapie offer for ITEX, he does have a nose for value. Biglari’s hedge fund enjoyed a big score last year in forcing the sale of Friendly Ice Cream Corp. He has also done very well over the past few years with his activist investment in Western. Bilgari’s interest in ITEX seems fairly obvious: he likes free cash flow stories trading at cheap multiples. At a closing price of $0.92 a share on Monday, ITEX is trading for just 11 times run-rate earnings of $0.08 a share, and for just six to seven times run-rate cash flow of $2.5 million. Taking into account ITEX’s limited trading volume and pint-sized profile, a fair value of $1.25 or higher seems reasonable.

ITEX is not without its risks. Stripping out a recent acquisition, ITEX’s top-line growth last quarter appears to have been less than 5%. While ITEX is nicely profitable, it is certainly not a screaming growth story. Even though ITEX looks cheap, if Biglari were to publicly lose interest in ITEX, the stock could certainly pull back. ITEX also has a limited balance sheet, which means it must continue to execute cleanly and it can’t afford missteps or a slew of new competitors.

Bottom line, for medium-risk investors, ITEX looks like an interesting play below the $0.90 level. Given ITEX’s average trading volume of just 24,000 shares, be sure to use limit orders.

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. Read More