Indigo Books & Music TSX:IDG $10.79

Indigo Books & Music Ltd is the largest (and only significant) chain of bookstores in Canada. It operates a variety of small and large format stores under a number of brands, and the business has been profitable and cash flow positive. It also had a stake in Kobo, an e-reader device company, which competes with Nook and Kindle. Management sold the Kobo business for $315 million, or approximately $145 million for Indigo’s share.

The company has had same store sales declines of ~5%, but margins have been improving as management changes the assortment to include higher margin gift items, housewares, and greeting cards.

The real item of interest here is the company’s cash position. Their most recent balance sheet showed cash of $314 million and total current assets of $588 million. Inventories and accounts payable of $269 million offset payables of $272 million. Inventory risk is not significant as books are typically returnable to the publishers by the stores if they don't sell, an odd quirk of the business.

The only other liability of any significance on the balance sheet is $77 million of unredeemed gift cards and deferred revenue. This float is valuable in a Zero Interest Rate Policy world, and inevitably some will not be redeemed. To be conservative, if we deduct the entire amount from cash $237 million of net cash remains.

This leaves an enterprise value of $36 million for a company with revenues of over $900 million in the last 12 months, and where profits are improving dramatically. The first three months of fiscal 2013 (most recent financials) show continuing operations earning $12.5 million, compared to a loss from continuing operations in the comparable period a year earlier of $17 million. The bottom line improvement is even more dramatic as the Kobo business was a consistent money loser, so its disposition removes a significant earnings drag.

Indigo also pays a $0.11 quarterly dividend, so there’s a bit of a ‘paid to wait’ quality to this idea. There is also the potential catalyst of an activist becoming involved. Canada has much weaker "poison pill" rules than the US, and US activists have been agitating for change at numerous Canadian companies. It seems probably that at the current price someone will "forcefully request" the cash in the business be distributed.

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