Vitesse is a little communication semiconductor company that has attracted some interest based on their product set and broad customer portfolio.  The real reason for the attention however was an overhang of convertible securities that might allow the stock to move up sharply if they were cleared away.

After what must have been tedious discussions with all the bondholders the company announced  a settlement and exchange offer yesterday. We had been waiting for the smoke to clear so we could reevaluate the equity in the event there might be an opportunity to exploit a short-term move in the shares.

The filing goes through the detail in gory detail so we will just summarize the outcome of the terms on the equity holders as follows:

• From a balance sheet standpoint the company should end up with about basically zero net cash or debt.  (They ended the most recent quarter with $57M in cash and will use 10M in the transaction and issue $50M in new notes.  They will draw on a credit facility for any shortfall and for working capital.  So there will be a few million but to keep things simple we will call it a zero.)
• The share count balloons thanks to a newly issued 173M (there are 231M shares currently outstanding) which takes the new total up to 404M. However to avoid going above the 9.9% ownership threshold they company will also be issuing a special preferred that is convertible into common.  Taking those additional 77.1M into account the count reaches 481M.  (Those preferred shares are convertible at 22.5c per share.)

Using TTM revenues of 168M and a 1-2x TEV/Revenue range it’s easy to compute a very rough valuation interval of $0.34 to $0.69 per share using the full 481M shares.  With the shares at $0.36 the stock certainly has some room if the company can begin to show some revenue growth.

Shareholder approval is still needed to complete the transaction so the company is not completely out of the woods as of yet. There don’t seem to be any analysts following the company anymore so there may be no expectations out there for how the company might do going forward.  Some of their fiber to the home initiatives seem to be on target.  There are some long-suffering equity holders out there that may be relieved to see that the company has achieved this agreement and will avoid effectively going out of business.

The price of freedom is high in the immediate term with more than a doubling of the diluted share count.  On October 1st senior management salaries went up to pre-crisis levels after a drop of 10-20% for the fiscal year.  So most everyone is happy and relieved although the public equity holder gets the least reward here in the short term.

Looking out further if VTSS can execute and show that revenues have at least stopped declining investors may anticipate a return to a $200M annual revenue run rate which has been “normal” for Vitesse for the past six years.  Affording them a 1.5x TEV/Sales puts the shares at the $.60 level.  The company still has the approvals to navigate and the need to show at least a quarter or two of growth to justify this level however.

In conclusion there is no major short-term opportunity here based on the terms of the settlement.  We wouldn’t rule out some kind of “relief rally” now that they are on a path that should avoid going out of business.

[Disclosure: The author has a very small position in some shares of VTSS to serve as a reminder to monitor the story.]