Where Others See Trouble...

Jeffrey Ubben is finding bargains in companies with accounting snafus

The news from MSC.Software Corp. turned from bad to worse. On Aug. 11, the Santa Ana (Calif.) company reported it was expanding a six-month-old internal audit at a foreign subsidiary. Because of the inquiry, MSC hadn't filed financial statements with the Securities & Exchange Commission for nine months. For many investors, the widened probe was the last straw -- MSC's stock fell to a 52-week low of $6.14. But for San Francisco hedge fund ValueAct Capital Partners, it was the beginning of what could be a beautiful friendship. The fund scooped up a million shares, which have since rebounded to as high as $9.89.

To Jeffrey W. Ubben, the firm's managing director, companies such as MSC are newfound manna. Thanks to tougher accounting rules, some public companies are forced to launch lengthy audits and delay filing their financials when snafus arise. Though the problems often turn out to be minor, a company's stock usually plunges during the delay, creating a buying opportunity. Before, these were rare, says Ubben, but they now make up a whole category of investments. His firm has invested a fifth of its $1.5 billion fund in such tardy filers. So far, it appears to be alone in dipping into such a treasure trove of undervalued gems. Ubben won't reveal the fund's returns, saying only that they've averaged in the double digits since its launch in 2000.

Ubben, 43, is best known for chairing Martha Stewart Living Omnimedia Inc. (MSO ) for 13 months, until last July, while the company's founder was fighting her legal battles. ValueAct owns 21% of Omnimedia, and Ubben has been a director since 2002. Before co-founding ValueAct, he was a managing partner at San Francisco private equity firm Blum Capital Partners. Ubben got his start at Boston's Fidelity Investments, where he managed the Fidelity Value Fund (FDVLX ).

He contends that weeding out the real deadbeats from the late filers is simple. "The cash flow doesn't lie," he says. ValueAct hunts for undervalued companies that are about 20 years old, have done few acquisitions, and generate roughly $300 million to $1 billion in annual sales from a core business. Their cash flows should appear highly consistent, making it easy to spot accounting trickery. When the fund finds a promising target, it begins buying stock, often seeking to become the largest outside shareholder. It then uses its influence to boost the company's performance over several years.

NEW STRATEGEM

The snags that hold up filings often start small. One company, Catalina Marketing Corp. (POS ), delayed its annual report in June, 2003, after the auditors questioned whether revenue in a division was added to the books at the right time. While an audit dragged on for almost a year, Catalina filed no financials, its stock dropped 33%, to $12, and ValueAct bought 12% of its outstanding shares. In the end, the company had to reassign revenue to different fiscal years, but total sales didn't change. The stock has since risen to $28.

Now ValueAct is adopting a new tactic: attempting to take late filers private. In September, tired of the continuing audit at MSC, it offered to buy the 91% of the company it didn't own in a deal that valued MSC at $274 million. Going private, ValueAct argued, would free MSC from filing public reports and reward long-suffering shareholders. MSC's board rejected the offer, saying the audit made it impossible to value the company.

But matters may not end there. "An offer to go private opens up a lot of eyes and ears," says Justin Cable, an analyst at B. Riley & Co. By making a bid, Ubben may have put MSC in play. If the company accepts a better offer, ValueAct won't gain ownership, but it will get a handsome return on its shares -- and more money to plow into another delinquent filer.

By Justin Hibbard in San Mateo, Calif.

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