Why The Street (NASDAQ:TST) May be taken out soon?

While I have written about The Street (NASDAQ:TST) in the past, it seems that I tend to write about it whenever I get more bullish on the stock. My recent optimism is borne out of several factors. Many of these factors have not changed since the last time I discussed it, but there are a couple of good new data points that not only lead me to be more bullish but to strongly believe that we will see a takeout of the stock in a merger or a buyout soon by existing large holders. The recent removal, or stepping down, of its current CEO is not the least of these reasons.

For professional investors, a CEO change is a noteworthy development at any company but more so at a perennial under-performer that is trading at a huge discount with lots of cash on its balance sheet. As anyone who follows the stock knows that TST has $75 million in cash sitting on its books. The question has always been: Why has TST not done anything with this cash? The answer lies with Technology Crossover Ventures, also known as TCV, a multibillion private equity and venture capital firm. You see, back in November 2007, TST pulled a trade that, in hindsight, not even Jim Cramer could have probably pulled at his peak as a hedge fund manager. The trade was that TCV invested $55 million in preferred stock and warrants that convert to common at an exercise price of $14.26 and $15.69 respectively. This investment gave TCV, among other things, Board representation, a virtual veto on any change of control, and prevented the company from doing any share buybacks or increasing the dividend which stands now at $0.10 a year for a current yield that is north of 5%. Now, since 2007 this investment has been collecting virtual dust for TCV. It is true that the preferred shares are entitled to a dividend, but that ends up being almost close to zilch. The actual dividends collected are what TCV is entitled to on the common shares given conversion. (Basically the $55 million convert into 3.86 million common shares at $14.26 and, as such, TCV collects an annual dividend at the current rate of $.10 a share equaling $386,000). Meanwhile, the conversion price is so high on the preferred shares and warrants that they are massively underwater at current share price levels of around $2. Basically, TCV has been “locked” up since November 2007. TCV is a huge firm (AUM $7.7 Billion) and $55 million are a mere drop in the bucket for them but you would have to think that they are not too thrilled with the ROI on their investment so far.

Until recently, Jim Cramer was Chairman of the Board at TST but that changed in February 2011 when he stepped down in an effort to “reduce his administrative duties” at the company and Woody Marshall became Chairman. In December 2011, TST announced that its CEO will be leaving by March 31, 2012. This technically leaves Woody Marshall in charge. Who is Mr. Marshall you ask? He is a General Partner at no other than TCV. It would be a prudent assumption to think that Mr. Marshall would like to get a better return on TCV’s investment or at the very least the return of TCV’s money. Given the conversion price for the preferred shares – $14.26 – it’s unlikely that TCV will make ANY money on this investment via conversion to common. The more likely route would be for TCV to take an action that will make it get its money back.

Before going into the numbers, it’s important to do a quick recap on TST’s business model. If you are new to the company, TST operates financial news site Thestreet.com as well as a premium newsletter subscription service written by celebrity contributors such as Jim Cramer and Doug Kass among others. From its website it generates advertising revenue that adds up to roughly 1/3 of total revenues and from the premium subscription service it earns the other two thirds. This sounds like a very sound and HIGHLY scalable business and indeed TST generated $57 million in 2010 revenues. Now what is unusual and quite hard to figure out is that how such a highly scalable and capital-light business ends up having operating expenses of $63 million in 2010. Full 2011 numbers have not been released yet but they are of the same order of magnitude with little improvement. Basically, TST does not have a revenue problem; it has an expense control problem. Rightsizing TST’s expenses is an overdue assignment that is most effectively undertaken by a Private Equity firm that takes the company private in my opinion. Also, it’s noteworthy that TCV is heavily invested in other internet companies, big and small, and TST can be used to roll up other companies into it or roll it into other companies TCV owns.

By the numbers, TST has $75 Million in cash as of the end of September 2011. In comparison, its current market capitalization, based on 32 million common shares, is a tad under $60 million. This obviously sounds unusual, but if you take out the $55 million in preferred shares, which is essentially a liability, you are left with $20 million in cash for a company with a market capitalization of $60 million. A mismanaged company that is almost breaking even on a GAAP net income basis, is cash flow positive, and has one third of its market capitalization in cash is always a company worthy of closer attention since those are very good starting points for a turnaround.

Another important number that should be highlighted is TST’s huge tax loss carryfowards that stood at $139 million as of December 31, 2010. Now tax loss carryfowards are severely limited in the event of a change of control, but, and I am not a tax accountant, one has to think that a go private event by TCV and current insiders, such as Jim Cramer who owns more than 7% of the company, in a manner that allows TCV to somehow increase its effective ownership of the company ex-ante can be enough to maintain the usability of the tax loss credits. On a common share basis, TST’s latest proxy statement indicates that TCV controls 13.7% of the company but on a total capitalization basis (common + preferred) TCV controls $55 million out of $115 million ($60 common market cap +$55 preferred) or 48%. In all events these tax credits are of value even if the company remains public and is managed in a way that increases income (by acquisitions for example).

The Cramer Factor
Another clue that leads me to believe that a takeout is imminent is the behavior of Jim Cramer – the company’s founder and largest individual shareholder. It’s clear to me that he is looking for an exit or at least making the company more inviting to a takeout by another entity. Through an automatic 10b5-1 stock sale program, Cramer has been selling stock in 2011 at an annual rate of roughly 200,000 shares – give or take. He is a large owner after all and selling is not so unusual for someone at his age and level of stock holdings but nevertheless, something tells me he would not mind see the company go private or him completely cash out in an advantageous way if it stays public. At a certain inflection point, which I think may have been reached, as a TV and media personality, being connected to TST as a public company holds him down rather than lift him up.

The biggest risk anybody assumes when buying TST is whether Jim Cramer will stay or leave the company as he is not only the company’s “promoter in chief” but he is also a major draw for its premium subscription revenues. Cramer’s previous employment contracts with the company gave him a great deal of power in the event of a change of control – the power to pretty much walk away if he so chose. However, his last contract, which was signed in December of 2010 and runs through the end of 2013, includes interesting language as mentioned by TST in its latest Proxy:

“The Current Employment Agreement does not provide for any cash payment to be made to Mr. Cramer upon the occurrence of a change of control, and limits Mr. Cramer’s ability to terminate the Current Employment Agreement in the event of a Change of Control (as defined in the Plan) or sale of the Action Alerts PLUS subscription service to circumstances in which Mr. Cramer reasonably believes that the ongoing association of his name, likeness or content with the acquirer would materially damage his brand, reputation or relationship with the broadcast or cable television network then producing and/or televising “Mad Money” or any successor show. By contrast, the Former Employment Agreement had provided that upon a Change of Control (as defined in the Former Employment Agreement), Mr. Cramer had the right to terminate the Former Employment Agreement and receive, subject to certain terms and conditions, a cash payment equal to slightly under three times his “base amount” (as defined in the Former Employment Agreement, which generally was similar to the definition in Section 280G of the Internal Revenue Code).”

So does all of this mean that a takeout will happen? Maybe. But at these levels I am happy to own the shares, collect a nice dividend and wait to see what TCV and Woody Marshall are going to do about their investment in TST. We will soon know more as the company will announce its full 2011 earnings on March 7. It will also give an update on the CEO search and its future plans.

Tagged Jim Cramer, NASDAQ:TST, The Street, TST