Emerson Radio (AMEX:MSN)

Emerson Radio Corp (AMEX:MSN) is one stock that appears to be a no-brainer. Its market cap, at $51m, is less than its net cash of $61m, yet the business is profitable, generating $7m of pre-tax profit in the last 12 months. Who wouldn’t be tempted by such numbers, until you learn the unpleasant truth about why this company deserves to be trading at such low multiples. Its management and owners are surrounded by countless accusations of corruption, so much so that if all are to be believed, shareholders of Emerson should expect nothing more than to be conned out of what is rightfully theirs. This is a warning to investors – an investment in Emerson as it currently stands is nothing more than a gamble on a change of ownership.

The business

Emerson Radio is one of the nations largest volume consumer electronics distributors with a recognized trademark in continuous use since 1912. Emerson engages in the design and marketing of audio and video products tailored to meet consumer preferences. The Company’s product line includes flat-panel televisions, VCR’s and DVD players, audio accessories, microwave ovens, home theatre, high end acoustic products, office products, mobile stereos and wireless products.

As you may have guessed, this isn’t a business with a lot of economic moat, they operate in a thin margin business, with low barriers to entry, and their two largest customers (Wal-Mart and Target) account for 87% of sales). This carries with it risks, and sure enough last year Wal-Mart decided to stop carrying some of its products, resulting in sales falling by almost a third.

But even that isn’t the reason the shares are so undervalued, the reason is a corrupt management. S&T, a subsidiary of Grande Holdings, controls 56% of the shares of Emerson. It is a Chinese company run by some of the same management of Emerson. In short, Emerson is run for the benefit of Grande Holdings, and no other. Grande holdings is currently in liquidation, whether this is due to excessive debts or to avoid litigation, is unknown.

Where do I even start, there are some many red flags with management that it would take almost a novel. Here are the most pertinent.

Management ‘avoid’ tax

In March 2010, the Board declared an extraordinary dividend of $1.10 per share. In connection with the Company’s determination as to the taxability of the dividend, the Board relied upon information and research provided to it by the Company’s tax advisors and concluded that 4.9% of such dividend paid was taxable to the recipients.

In August 2012, the Company received notification from the IRS which challenged the Company’s conclusions and stated that 100% of the dividend paid was taxable to the recipients.

In the event that (1) the Company is not successful in establishing with the IRS that the Company’s calculations were correct and (2) S&T is unable or unwilling to pay the additional taxes due or indemnify the Company under the terms of the Amended Agreement, the Company may be liable to pay such additional taxes.

Restatement of prior years income

The IRS doesn’t just take issue with the special dividend, it is also taking issue with the tax avoidance measures management are using and has stated that income for the years 2010-2013 has been understated. If the company does not successfully defend against this claim they will receive an additional tax bill of $13.3 million. The company also estimates it will owe $4.4m extra on unpaid taxes on other non-operating income.

Litigation against the management

On July 7, 2011, the Company was served with an amended complaint filed in the United States District Court alleging that certain of the company’s present and former directors (and other entities or individuals now or previously associated withGrande), intentionally interfered with the ability of the plaintiffs to collect on a judgment (now approximately $47 million) they had against Grande by engaging in transactions (such as the dividend paid to all shareholders in March 2010) which transferred assets out of the United States. This matter is scheduled for trial on October 29, 2013.

Grande Holdings history

A quick search on this company yields interesting results. It has been involved in dealings in the past which were alleged to have been used to move assets out of the reach of claims against directors. Here is a Bloomberg article on the issue. A company called Akai, which was in financial difficulty and subsequently liquidated, mysteriously transferred key assets to Grande Holdings without any notification to the stock exchange.

Resignation of Audit committee chairman

I have saved the most damning evidence until last. Soon after Grande Holdings took control of Emerson, the audit committee chairman resigned and wrote a damning resignation letter accusing management of exploited Emerson. The letter can be read in full on EDGAR.

“Upon joining the Board, I was optimistic regarding prospects for Emerson under its new management. Relationships with The Grande Holdings Limited and its various affiliates promised favorable opportunities for Emerson. Those positive impressions were disabused upon my discovery of egregious related party transactions that were planned and executed by Grande-affiliated directors and employees, to Emerson’s terrible detriment. Rather than gaining opportunities from Grande, Emerson was exploited as a financial resource by Grande in ways both large and small, direct and insidious.”

Light at the end of the tunnel?

By now you should be, quite rightly, scared away from these shares. There is clear evidence that not only are Emerson directors exploiting the company and minority shareholders, but they have a history of shifting assets off shore and out of the reach of creditors.

But there may be light at the end of the tunnel. As I said previously, Grande Holdings is in liquidation, but now it has been explicitly stated that it is selling its Emerson holdings. Read the full filing here.

“On September 12, 2013, the High Court of Hong Kong issued a judgment to formally wind-up Grande Holdings, and the company is currently in liquidation. The Provisional Liquidators have informed Emerson that they are exploring a potential sale of the 15,243,283 Emerson Shares beneficially owned by Grande Holdings, and this process is currently ongoing.”

I have no idea who will end up buying these shares, but if it is a company unrelated to the current management it may suddenly become an interesting investment. Until then, I’m staying away.

I contacted management for some statements in relation to the content of this article but received no reply.

Disclosure: MSN – no position