Navarre Corp’s sale of FUNimation: Ignoring the forest for the trees? ($NAVR)

I wrote about Navarre Corp (NAVR) in early March, noting that an activist investor could act as a catalyst.

It appears that NAVR’s free cash flow generating capabilities has attracted an activist investor. In November, Becker Drapkin Management, LP of Dallas, Texas, filed a Form 13D indicating that it had purchased 15% of the company. An exhibit to that filing includes a letter that was sent to NAVR’s management demanding, under the Minnesota Business Corporation Act, the release of a slew of information.

As you will recall, NAVR publishes computer software and multimedia products and distributes software and multimedia for major technology companies including Symantec , Kaspersky Lab, Roxio, Webroot, McAfee, Corel, and LucasArts. In 2010, the company announced it would attempt to sell a subsidiary, FUNimation Entertainment. From that point, the company classified FUNimation as discontinued operations. On the company’s last 10-Q, it was carrying this division at a book value of $28.5 million.

On April 4, the company announced it had reached an agreement to sell FUNimation. Furthermore,  the company stated that it ended fiscal 2011 with zero debt (emphasis added):

“We ended fiscal 2011 debt free, prior to our receipt of the proceeds from this transaction,” said Cary L. Deacon, chief executive officer of Navarre Corporation.

Normally, I would be happy to hear that a company was selling a non-core asset, had eliminated its debt and added a significant amount of cash to its balance sheet. However, in this case there are a few things that worry me. First, the transaction is for $24 million cash, or 15% less than book value. Additionally, the division produced ~$4.4 million in net income in the first 9 months of fiscal 2011 (similar to the first 9 months of 2010). Using a straight line projection, this would be $5.9 million for the year, so the sale looks to have been completed at a ~4x P/E. The company currently trades at a 6x multiple. Is the company’s interest in focusing on distribution causing it to lose sight of the big picture (earning returns for shareholders)?

Beyond the questionable sale price, investors have little to cheer about when it comes to the ultimate use of the cash proceeds:

“With the strength of our balance sheet, Navarre will be able to deploy the funds generated from the sale of FUNimation to build or acquire new businesses and services to diversify our revenue streams that will support our long-term objectives. We will be actively seeking expansion opportunities in the distribution and online/web services area to support our direct to consumer strategies.

Instead of returning cash to shareholders, the company is committed to re-investing the cash to acquire new businesses. This makes an investment in the company speculative, as investors have no ability to judge whether a significant asset (the $24m cash) will be put to good use or not.

Author Disclosure: No position

Talk to Frank about NAVR