Rising Star Buy: Imation

This article is part of our Rising Star Portfolios Series.

I'm excited to recommend and open a position in Imation (NYSE: IMN  ) .

The business
Imation is a global developer and marketer of recordable optical media, magnetic tape media, flash products, and consumer electronics. It operates under the Memorex, Imation, TDK Life, and XtremeMac brands. At some point in your life, you've probably bought CD-R's, DVD-R's, or a flash drive of theirs. The company was spun off from 3M (NYSE: MMM  ) in 1996 and has been a standalone entity ever since.

Why I'm buying: It's cheap
As fellow Fool Andrew Bond recently pointed out, assuming full value of accounts receivable and inventory, Imation is trading below its net current asset value (NCAV). At a price of $9.46, the company trades around 88% of its NCAV of 10.76. That's absurdly cheap.

The company has no debt and loads of cash and other current assets. If you were to strip out the cash and other readily monetizable assets, the market is pricing the business at roughly negative $50 million.

Looking at the company through the lens of net income, you would get a sense that this might be the right valuation. Imation lost $14 million these past 12 months and $42 million the year before that. However, when you examine the company from a cash flow standpoint, another picture emerges.

The company generated nearly $130 million in cash these past 12 months and $55 million the year before that. I expect the company can continue to generate positive cash flow and, as its restructuring program continues, earnings to turn positive.

Management wants to unlock value
In Imation's most recent conference call, management promised to provide more details on its strategy for "return of cash to shareholders" going forward by the next conference call. This should be sometime in mid- to late January. The company had a history of paying a quarterly dividend before the credit crisis required the company to suspend its dividend. Reinstating the dividend would help others take notice of the business and bring its valuation up.

And no one cares
Only two analysts were on the most recent conference call, and only two analysts are listed as following the company on Yahoo! Finance. This is a company flying under the radar of Wall Street and most investors.

Risks
The company is facing headwinds, storage technology continues to become cheaper, and the company must continually innovate to stay competitive on price. While the company has suffered over the past two years, it has shown it can generate cash while effectively competing.

Imation's management has said acquisitions are in the realm of possibility. The company's last acquisition of Memorex didn't work out so well. This will hopefully be addressed in the next conference call.

Summary
I'm buying $1,000 worth of shares of Imation tomorrow. At this price, your downside is protected by the company's NCAV and its ability to generate cash. We will find out more about management's strategy in January -- until then, I have no problem sitting on an undervalued stock.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Dan Dzombak recommends that you read The Best Investment Advice You Will Ever Get. He owns no shares in any of the companies mentioned. Find him on Twitter at @DanDzombak to check out his musings and see what articles he finds interesting.

We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 08, 2010, at 4:52 PM, sydisquid wrote:

    how can a company be FCF positive and lose money at the same time?

  • Report this Comment On December 17, 2010, at 2:17 AM, ndavis90210 wrote:

    "How can a company be FCF positive and lose money at the same time?"

    By "lose money", I assume you mean having a negative net income. The short answer is: because net income not the same as net change in cash.

    It's not that unusual for a company to be FCF positive but post a negative net income (or vice versa). There are many expenses that appear on the income statement that do not affect cash -- depreciation, stock-based compensation, etc. Thus, there can be a huge difference between the cash flow statement and the income statement.

    The key is to recognize when the differences between cash flow and the income statement reflect a positively on the company's future and when they reflect negatively. For example, expenses that have already been paid for, but haven't been recognized on the company's income statement won't be a drain on cash flow in the future. Increases in accounts payable, on the other hand, may mean that the company is short on cash. In either case, more investigation is needed to ascertain the cause -- knowing the source is not enough.

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