Highway Robbery: Portal Player (PLAY) Gets a Buyout Offer from NVIDIA (NVDA)

By: Steve Rubis

The company Portal Player is being bought out buy NVIDIA for a price substantially less than liquidation value. For this reason, we believe that this senario has both educational and illustrative value to our readers.

Here at Stock Research we spend most of our time these days creating spreadsheets in order to generate investment ideas. One of the ideas that developed through this research was the company Portal Player (PLAY). The company originally provided an integral component to Apple’s (APPL) IPOD, but upon creation of the Nano, PLAY's products were no longer essential to Apple. This unfortunate contract loss led to a significant decrease in sales, and in turn, a much lower share price. What makes PLAY interesting is that this company screams buy despite its revenue and earnings troubles. The theory that PLAY is great buying opportunity was validated by the buyout offer received from NVIDIA (NVDA). It is our contention, which we will prove below, that NVDA is robbing the PLAY shareholders with such a low buyout price. Currently, NVIDIA is getting $200M in cash for nearly nothing.

The case of Portal Player is both illustrative and educational. At first glance, PLAY was just another undervalued company with no compelling story in our eyes. After a quick review this morning, it looks as if PLAY is a classic value stock. It exhibits all of the classic signs; significant cash with no debt and a substantial Net-Net Value. A quick review of the financials is all that is needed to see that this company is a steal at current prices, the NVIDIA buyout offer included.

Let us start by quickly analyzing the business model. PLAY was a major provider of microchips for Apple’s IPOD. With the recent introduction of the IPOD Nano, Apple has been able to shrink the business it does with PLAY. This significant drop in revenue for PLAY caused a precipitous share price drop; the 52-week high was $33. The majority of Wall Street Analysts believe that this low buyout price shows that there are problems with PLAY. Certainly, the loss of revenue is a significant issue, the problem is that those who believe the company was sold for an equitable price fail to truly understand financial analysis.

Where PLAY becomes of value to us is in its educational and illustrative aspects as a classic value stock. Anyone who performs the rigorous analysis applied by value investors will see that PLAY has been given away for $13.50. The crux of the buyout revolves around PLAY’s pristine balance sheet, considering it has $195M in cash and no debt. When analyzing the buyout price, the cash position is significant and will prove that this deal is robbery.

At this time, we should review the metrics of the current deal that is on the table. NVIDIA has offered to buy PLAY for $13.50, which is about a $344M market cap for PLAY. This price yields the following metrics:

1.) P/E: 10.36
2.) P/S: 1.57
3.) P/B: 1.57
4.) P/EBITDA: 9.08
5.) EV/EBITDA: 3.83
6.) Buy out price: $13.50

The unsuspecting investor might believe that these are reasonable metrics for this deal. If the investor in PLAY accepts these metrics at face value, he should really get out of the market. These metrics seem quite low for a typical M&A deal in any industry. In order to get real valuation metrics of this deal, analysts must subtract the $195M cash position from the market cap of PLAY. Subtracting the cash yields the following:

1.) P/E: 4.39
2.) P/S: 0.66
3.) P/B: 0.66
4.) P/EBITDA: 3.85
5.) EV/EBITDA: 1.0
6.) Real buy out price: $5.72

This deal is tantamount to NVIDIA robbing PLAY shareholders. NVIDIA is buying a corporation with real assets worth more than the price being offered to purchase them. If we look at a few other value metrics, it becomes apparent there is something wrong with this deal.

1.) Net - Net Value: $7.74, which is synonymous with liquidation value
2.) Earnings Power Value (EPV): $5.03 per share, this is based on a WACC of 25.88% and Net Income (ttm) of $33.22M
3.) Relative Analysis Value: the price ranges from $7.16 to $39, for an average of $27.
4.) Earnings Yield: 10% based on $13.50 price, and 22.7% based on “real” buyout price

Also, look at the following values:
Take Out Value: $7.16
P/E Value: $32.99
P/S Value: $30.81
P/B Value: $22.90
P/FCF Value: $34.04
DCF Value: $39.00

The only problem with our analysis is how do we reconcile the EPV to the asset values we calculated. According to our calculations, the PLAY franchise is worth $2.71 (the difference between EPV and Net-Net Value). We think that the Net-Net Value and Net Cash positions prove that the buyout price should be higher than $13.50 per share. Certainly, it seems a stretch to expect a take out price in the high $20’s, with a minimum buyout price of $16.21. Our mimimum price takes into account the franchise value for PLAY's products. Despite the earnings issues that surround the company, we think that the assets are worth well more than $13.50 and are probably worth something closer to $20.00, at least the mid-teens.

At this time, we do not recommend buying PLAY, but think the situation is worth watching so that we can note how the senario unfolds.