Tuesday, August 12, 2008

Buyback with a Twist

Extreme Networks, Inc. (EXTR: Nasdaq) announced its intention to buyback up to 27.0 million or 26% of its outstanding shares. That would be a $100 million value if completed. This is not your usual stock buy back - there is a twist.

The Company’s stock has floundered in the last three years, falling by 70% from a five-year high $9.80. The sell-off is not surprising given the red ink that started flowing in the final quarter of the fiscal year ending June 2006. Extreme Networks provides network infrastructure equipment for corporate, government, education and telecommunications networks. Sales dipped in fiscal year 2007 on a slowing in capital spending by customers in nearly all its vertical markets.

The spending environment continues to be a concern but cost controls other “right sizing” adjustments to the Company’s operating structure helped restore profitability in the October 2007 quarter. The stock has failed to recover.

Despite the net loss in FY07 Extreme Networks broke even on a cash flow basis. Indeed, the Company is a veritable cash machine with an average cash conversion ratio of 4.2% in the last three years. At the end of June 2008, the Company had $113.3 million in cash burning a hole in the corporate pants pocket.

Management is set to make a tender offer to shareholders using the Dutch Auction process. Normally used by issuers for initial or follow-on offerings of common stock, in this case shareholders can make a bid to sell their EXTR shares back to the Company. The Company has already set a price range of $3.30 to $3.70.

Like all other buyback efforts, the tender offer is likely to soak up excess shares that would normally show up at the bid price. Since an average of 1.2 million share trade on any given day, the maximum buyback in terms of shares represents approximately a months worth of trading volume.

The Dutch Auction platform may mitigate some of the bidding up that normally accompanies buyback efforts. Yet do not expect the share price to remain unaffected by the presence of the Company as a new buyer for EXTR shares. Indeed, buyback announcements represent another form of insider purchases as a buy signal for stocks.

My manta is still “follow the buyback announcement,” even the ones with a twist on execution.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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