Klarman Searches For Bargains: 1991 Barron's On Spinos

1/03/2016 5:40 pm

The Value Hunter Seth Klarman Searches For Bargains Barrons

1991 Interview Spinoffs
Continued from part two.
Moving away from distressed debt, Seth Klarman started to discuss a traditional Graham and Dodd
value play that he was currently interested in.
The company in question was called Esco Electronics, a spinoff from Emerson Electric.
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Seth Klarman: True value

Esco Electronics was a traditional value play that was trading at such a deep discount to book, it was
difficult to pass up the opportunity. Indeed, at the time Esco was trading at only 8% of book value, had
over 6,000 employees working over three million square feet of space, generating over $500 million of
sales per year, but the company's market value was a miniscule $35 million when Klarman started
buying.
By the time of the Barron's interview, Esco's market value had risen to $70 million, $6 1/2 per share.
Klarman believed that the company was worth at least double.

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Klarman Searches For Bargains: 1991 Barron's On Spinos

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"...when we look at this company, a good part of their business comes from the Hazeltine
acquisition. In fact, the company's goodwill also comes from that acquisition. They bought
Hazeltine about four years ago for, give or take, $180 million. That is alone $15 per Esco
share. So if everything else they have is worthless and Hazeltine is worth 40% of what they
paid for it, that explains Esco's stock price right there."
Esco was spunoff from Emerson Electric. Emerson, which had been trying to sell Esco for several
years, wanted to get rid of the subsidiary without selling it at a knock-down price that would have
blemished its reported earnings.
"The best thing of all is that the company was spun off with virtually no debt. I think that, at
the time of the spinoff, it had $25 or so million of debt. And their debt is down to $18 million
total, including short-term and long-term. And they have $42 million of cash on the books.
So in fact, this company has almost $4 a share of cash, or $2.25 a share net of debt."
Esco had a book value of $40 per share and tangible book value of $26. Cash flow from depreciation
and amortization alone totalled $22 million per annum. But Seth Klarman identified several factors
holding Esco back. Firstly, the company was booking hefty goodwill amortization charges from the
Hazeltine acquisition, which amounted to $0.50 per share per year. The second factor holding the
company back was a $7.4 million-a-year charge for five years that Emerson had put in place as a
guarantee fee. This charge amounted to $0.50 per share per annum.
The third factor holding Esco back was a number of fixed-cost development contracts that the
company had entered into, but was struggling to complete on budget, tying up capacity and working
capital.
All of these three negative factors were, of course, temporary.
"Seth Klarman: Of course, the thing we like about it is we don't know how high it can go. We
imagine that if it came into favor the stock could double or triple or more. The key thing for
us is we don't think there is a lot of downside. Given the tangible assets, given the cash, given
the cash flow, we would be very surprised to lose money over a meaningful time frame
here."

Seth Klarman: Final pick

The Barron's interview then moved on to Seth Klarman's final pick, Safeguard Scientifics.
Safeguard was another clear value play, as Klarman explains:
"They own approximately 70% of CompuCom, a computer reseller. And the value per
Safeguard share of their CompuCom of about 2 3/4 just about explains the entire market
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Klarman Searches For Bargains: 1991 Barron's On Spinos

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capitalization of Safeguard. That is worth about $55 million at current market, and
Safeguard's market cap is about $62 million. So just the CompuCom and the Novell [another
shareholding] alone are worth, at market prices, $15. And the stock is trading at $12."
"In addition to that, they have a number of other businesses, all doing better than they have
done over the past several years...They also own some warrents in QVC, the homeshiopping company, which are worth at market price about $8 million. And several other
situations."

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