Xyratex – Ben Graham’s Famous Net-Net Stock

When Ben Graham wrote Security Analysis in the 1930s, he introduced his famous net-net stock to the world. To pass his net-net test, a company is valued solely based on its current assets minus all its liabilities. The idea was that when a company is identified as a net-net, the stock is as good a bargain as it can be, assuming that the business will continue to be viable. Today, not many companies pass this test, but this article examines one that does – Xyratex Ltd (XRTX).

Briefly, Xyratex is a UK-based data storage technology provider that generates sales in the United States, Europe and Asia. In fiscal year 2011, 93% of their revenue was made up of sales to its top six customers: NetApp Inc., Dell Inc, IBM Corporation, EMC Corporation, Hewlett-Packard Company and Seagate Technology.

Since the beginning of September 2012, the stock has been in free fall – losing 30% of its value as they missed sales estimates for the third quarter. In addition, management has announced that it will be recording a loss in the fourth quarter of 2012.

Perhaps because of the extreme negativity surrounding the stock and the small market cap size of the company, the market might have overreacted and punished the stock too harshly. At a market cap of close to US$200 million, Xyratex has zero debt and a cash pile of US$103 million in the latest quarter ending August 2012. With 27.5 million shares outstanding, the cash pile alone is worth $3.74 a share alone (half of its current share price).

Furthermore, total current assets are worth US$465 million on its latest balance sheet while total liabilities are at US$162 million. This gives us a back of the envelope net-net value of no less than US$300 million (compared to its current market cap of US$200 million).

While the near-term earnings power of Xyratex’s business might be questionable, there is no doubt that the depressed market capitalization along with its strong balance sheet merits a second look at the company. Furthermore, Xyratex started paying out dividends in FY 2011, distributing US$0.28 per share in the last twelve months of reported earnings. That translates to an annual dividend yield of 3.8% – essentially resulting in an investor getting paid while waiting for the market to readjust its valuation of the company.