How SurfStitch Could Give Shareholders a 70% Return

We can’t always pick winners in the stock market. Investors who bought into SurfStitch Group Ltd [ASX:SRF] this year likely regret their decision now.

The stock is down more than 60% year-to-date and now has a market cap of around $18.9 million, down from $590 million in November 2015.

This morning, the company said they’re facing litigation from Crown Financial Group. According to The Australian:

SurfStitch says it is exploring the option of selling media assets and other asset sales as it faces litigation from Crown Financial group, separate class actions in the Queensland and NSW supreme courts and a continuing ASIC investigation — all of which are expected to impact its cash position.

Yet the better option might be to sell off assets entirely and returns capital to owners — the shareholders of the business.

A 70% return from a company on its knees

In their half-yearly results, SurfStitch had $87.3 million in total assets and $44.4 million in total liabilities. Most of the company assets are actually made up of current assets ($73.5 million), with $33 million in cash.

The company is in trouble now and has an uncertain future. Yet that doesn’t negate the fact that the company is trading at a deep discount to their assets.

Let use an example to see how investors could potentially get a 70% return from the company.

Let’s SurfStitch decided to throw in the towel. And that they wanted to return capital to shareholders. They’d sell off their assets, pay off all obligations, and return what’s left to shareholders.

Well, if we assume their balance sheet is the same as it was in the half-year report, SurfStitch had net assets (total assets minus total liabilities) of $42.9 million. But, just to be safe, lets deduct total liabilities from current assets.

So SurfStitch could have sold off all assets, paid all obligations, and returned around $29.1 million to shareholder, or 12.8 cents per share.

Now imagine you had bought SurfStitch at 7.5 cent, just before the stock went into suspension. By winding up the company and returning capital to shareholders, those who bought in at 7.5 cents stand to make 70.4% on their investment. Not bad for a stock that many investors have given up on.

But this scenario likely won’t become a reality. As The Australian reports:

“The company is working steadily to stem losses within the business, improve the key underlying retail business operations and deal with the litigation challenges in an orderly fashion,” the retailer said in a statement.

But it added: “In light of the challenges facing the business, the company is exploring sales of its media assets and the potential for sales of other assets.”

So while it might be something for existing investors to dream about, bargain hunters might want to steer clear of SurfStitch as they sell off assets to survive a costly legal battle.

Regards,

Härje Ronngard,

Junior Analyst, Money Morning

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