In this environment, I’m looking for cheap and unexciting places to put cash until I come across a high-quality company selling at a cheap price.  At recent prices, Peerless Systems (PRLS) might be such a cheap and unexciting place.

Peerless is trading at a significant discount to net cash.  Despite $48 MM in cash and $9 MM in total stated liabilities, Peerless is only trading at $28 MM.  The company has recently undergone a significant change in its board of directors.  During the later part of 2008, Peerless’ CEO resigned as CEO and Director and left the board with Timothy Borg, Steven Bathgate, and Steven Pully.  These directors are an experienced group and their bios can be seen on the company website: http://www.peerless.com/.

What makes PRLS different from any other cheap microcap lying around these days?  It’s looking like shareholders may soon realize underlying value as the company recently announced a material corporate event that highlights the potential for a definitive realization.  On February 3, 2009, Peerless announced the termination of two leases, both effective January 30, 2009, at a cost of $2.7 MM—leaving the net cash balance at $8 MM.  One of these leases pertained to Peerless’ headquarters in El Segundo, and the company announced that it had “not yet determined the address of its principal executive offices following February 28, 2009 [the termination date of the lease].”  With February 28, 2009 quickly approaching and no determination on the location of Peerless’ headquarters, potential outcomes involving a special dividend greater than the current share price or an orderly liquidation may appear more probable.

In an 8-K filed July 7, 2008, the board announced their desire to acquire or merge with what amounts to a high-quality, mid-market company.  The major risk in Peerless is a the pursuit of a value-dilutive acquisition.  There hasn’t been any news regarding Peerless’ acquisition hunt since last July, and it doesn’t appear that the current directors are perversely incented to pursue a value-dilutive acquisition.

As February 28, 2009 approaches—and passes—shareholders can reasonably expect clarity on which the direction the board has chosen: the definitive realization of underlying value or a continued pursuit of announced acquisition strategy.

Serious about Sirius Bonds

I have been an XM satellite radio subscriber for 6 years. I love it. In fact, I really can’t imagine driving in my car without it. The combination of music , the comedy channels and various news and talk radio are wonderful. Most channels don’t carry any commercials and those that do limit them to 30 seconds at most. And there are around 20 million paying subscribers. All of us pay a monthly fee (around $10 a month with a range of $6 to $12).

Last year, XM and Sirius merged and created a monopoly. After years of competing against each other and spending ridiculous amounts on people like Howard Stern, Martha Stewart, the NFL, MLB and Oprah, they are now one. However, they are saddled with lots of debt, over $3 billion.

As the financial crisis has deepened it has looked less and less likely that Sirius can refinance their debt coming due this year, especially as they are still losing money, even though losses are shrinking. The stock has cratered and trades for pennies.

Enter Charlie Ergen, the CEO and co-founder of Dish Networks (NASDAQ: DISH) and Echostar (NASDAQ: SATS). Mr. Ergen is regarded by many investors, especially value investors, as one of the sharpest and best operators around in the media industry. So imagine my surprise, when I learned that Charlie Ergen had acquired controlling stakes in two tranches of junior debt coming due in February and December. He has been acquiring these stakes for months. And last year, he offered to inject capital into Sirius for a controlling stake in the company. Sirius demurred.

Now there is debt that comes due February 17th and Charlie Ergen controls that debt. Sirius has three options: 1)find a white knight 2)make a deal with Charlie Ergen 3)file for bankruptcy. The first two options are clearly the best options for debt holders, but would probably wipe out the equity holders. Bankruptcy would throw everything into chaos and who knows what would happen to subscribers in such an event.

There is a complicating factor here. Charlie Ergen and Mel Karmazin, the CEO of Sirius, don’t like each other. There is a serious risk that good ol’ Mel tanks any deal with Ergen and sends it into bankruptcy, because he has nothing to lose. He would lose control anyway and he has previously spent $100 million buying Sirius stock. Bankruptcy could send the bonds, especially the ones Charlie Ergen bought, into a tailspin.

And this is why the senior debt to the tranches that Charlie Ergen bought still sell for about 40 cents on the dollar. Here is the opportunity.

I believe that businesses with 20 million subscribers don’t get liquidated, especially as they continues to grow. I also believe that Charlie Ergen is a very shrewd operator and that he is not in the business of throwing away hundreds of millions of dollars. Thus, I believe Sirius debt is an excellent buy. I have bought the Sirius 9.625% 2013 which traded on Thursday (Feb. 12) around 40-41 cents. I’m viewing my debt as equity, hoping that one day I will own a much less levered company with a monopoly franchise that, with the right cost structure and discipline, will be a cash cow.

Of course there is a downside. What happens if Sirius declares bankruptcy? What happens in liquidation? Based upon my own analysis of the value of the satellites, the ground stations and other assets, I think those Sirius 2013 bonds are worth 60 to 70 cents on the dollar. But this could be a drawn out affair and in the short run the bonds would sell off. 

Sirius has been talking to Liberty Media (NASDAQ: LCAPA), which controls DirecTV  (NASDAQ: DTV). Whether this is a negotiating tactic with Ergen or for real, it probably can’t hurt to have more suitors at the table.

Aaron Edelheit is portfolio manager of Sabre Value Fund.