Genius — Formula Systems pulls a Berkshire HathawayPosted: February 28, 2014
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In earlier postings (here and here,) I wrote about Formula Systems (1985) Ltd., a company that generated $785 million in revenues and $22 million in net income over the last twelve months, while — and this is no mean feat — maintaining zero debt and growing both revenues and net income significantly.
The point of my earlier postings was that the company, which controls three companies (Matrix IT Ltd (traded on TASE as MTRX,) Magic Software Enterprises Ltd. (traded on Nasdaq and TASE as MGIC,) and Sapiens International Corp. NV (traded on NASDAQ and TASE as SPNS,)) has a market-capitalization that is significant lower than the market capitalization of its controlling stake in its three subsidiaries.
In my postings I explained how this capitalization discount was a function of holding company discount, a quite common occurrence, and I also explained how the holding company discount could sometimes become a holding company premium, as it is the case for Berkshire Hathaway:
Holding companies are not unusual either. Rather, they are the norm. For instance, Berkshire Hathaway, perhaps the world’s most successful company, is a holding company. In Berkshire Hathaway there is clearly no discount (in fact, in Berkshire Hathaway’s case there is a premium, with the value of the sum (the holding company) exceeding the value of the parts (the subsidiaries,) which is predicated on a decade long establishment of trust in the investment worthiness of the subsidiaries and the integrity of the principal managers, Mr. Warren Buffett and Mr. Charlie Munger.
Formula Systems is, without a doubt, undervalued by the market, but its credit rating is stellar — a function of an incredible balance sheet and incredible, sustained growth on a near-zero debt basis.
And so, recently, the company did something unusual: It took on approximately $50 million in debt through a commercial loan.
Why?, you ask. After all, the company, directly and through its subsidiaries, holds more than $100 million in cash, so why in god’s name would Formula Systems take on an interest bearing loan.
Well, the simple answer is, of course, that the loan is cheap and that there is no reason to not bite when given access to a carrot.
This leaves only the question of what to use the cheap cash for.
Yesterday afternoon an answer to that question started emerging, when Magic Software announced a secondary offering for six million shares and with, this morning, Formula Systems and Magic Software announcing that, in a totally unrelated move (hint, hint, wink wink) Formula Systems would acquire 700 thousand shares of Magic Software in the secondary offering at a price of $8.50.
This move is clever on so many levels that it borders on genius.
First, with the secondary offering, Formula Systems had to top off the tank on its holding of Magic Software stocks in order to maintain control. Second, with one bold stroke Formula Systems solidified Magic Software’s offering by guaranteeing almost twelve percent of the available shares. Third, with a offering pricing of $8.50, a ten percent discount over yesterday’s trading price of MGIC, the equity of Magic Software on Nasdaq, Formula Systems secured its top off at a staggering discount to the market.
Yes, for sure, the announcement of the secondary offering shook the market this morning, resulting in a market capitalization drop of almost ten percent for Magic Software, but that, as we know, is immaterial, reflecting only the market’s lack of fundamental understanding of secondary offerings and the inherent value of Magic Software. In fact, I would wager dollars to donuts that MGIC will quickly — very quickly — rise to a per share price that is higher than yesterday’s close, reflecting the size of the secondary offering ($51 million,) the implied acquisition and/or expansion, and Magic Software’s incredible track record in the areas of acquisition and growth.
But that is not what is notable. What made me pay attention is that Formula Systems did was exactly what a first rate holding company is supposed to do: use its stellar balance sheet as leverage, helping a subsidiary achieve velocity.
Oh, and the money given to Magic Software are not going to go to waste. Magic Software, which has a track-record of growing capitalization, revenues, and net income at a staggering pace, can now, without breaking a sweat, acquire a company in the price range of between $75 million and $150 million (after the closing of the secondary offering, cash on hand in Magic Software will be bumping up against $100 million,) and, in fact, I would expect to see Magic Software make a major acquisition soon — very soon.
By the way, it is also possible for Magic Software to issue a special dividend in the range of $1 per share, which would be a real stunt, immediately returning $20 million to Formula Systems.
So, there we have it…
Take that Berkshire Hathaway!
Dont be a Mooch!
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