MARKET COMMENT
Hunting For Cash-Rich Techs

By Stuart Watson (TMFTiger)
November 11, 2002

Hunting for cash-rich shares has become a favourite pastime for many investors in the last few months. Many technology companies, having raised lots of money when they floated in 1999 or 2000, have dramatically cut back their operations. Getting to profitability as quickly as possible and basically just surviving has replaced plans for global domination of multi-billion pound markets.

One such company is the Internet security group nCipher (LSE: NCH). It has a cash pile of £101m and only consumed £0.1m of cash in the last six months. This morning it announced plans to return £65m to investors sometime in the first six months of 2003. It plans to keep the remaining £35m to fund small acquisitions at what it hopes will be knock-down prices. But if suitable targets are not found, then this cash could find its way back into shareholders' pockets too.

Unlike many companies in its position, nCipher has not been particularly profligate with its cash. It bolstered its finances by raising £100m when it came to the market in October 2000, adding to its existing cash reserves, and has 'only' spent some £7m since then. However, those flotation shares were sold at 275p, a far cry from the current price of 65p and the recent low of around 50p.

So what about hunting out cash-rich shares as a strategy? Buying a £1 for 50p, or even 75p, is often a profitable pastime. But it can be fraught with risks for the private investor and it's not for the impatient. The biggest risk is not really being able to tell what management's intentions are. Will they do the right thing and hand back excess cash, or will they stubbornly stick to their original plans? Often, an aggressive third party is needed to force their hand and unlock the value. But if the management team and its allies own a sizable proportion of the shares, this can be difficult.

On the flip side, there is often limited downside risk. The cash balance frequently provides a floor of sorts for the share price, unlike companies in debt where the share price can easily go to virtually zero. Many companies will trade at a discount to their cash reserves, to reflect investors' uncertainty that a handout will be made or fears that some of the cash will be spent before it happens. Discounts of 20%, 30% or even 50% are not unheard of. Despite a rise in its share price this morning plus a reasonable guarantee of a payout to come, nCipher still trades at an 18% discount to its cash balance. Sometimes the rewards for this sort of strategy can be smaller than you think and if you're unlucky enough to pick the wrong shares, they may not even outweigh your transaction costs.