Infospace Inc. (NDAQ:INSP) may face some shareholder criticism in the near future after Sandell Asset Mangement disclosed an 8.8% stake and expressed their concerns over the company's lack of definitive plans to return capital to shareholders and its apparent complacency on cost controls. Tom Sandell, the CEO and Senior Portfolio Manager of Sandell summarized the hedge funds stance best, stating, "We believe that InfoSpace shares are materially undervalued and the board and management should take immediate steps to improve that value. If the company and the board are unable or unwilling to take these steps, we think the company should be sold. As the company's largest shareholder, our interests are directly aligned with the rest of the shareholder base in seeing value maximized and we may seek representation on the board to protect those interests." Specifically, the hedge fund seems most concerned that the company's actions have obscured the profitability and cash flow strength from the company's search/directories segment and impaired the value of the company's largest asset - a NOL (net operating loss) carry-forward topping $1 billion.

Sandell insists that the company is undervalued due to several factors:

1. Cash - The market is not giving full value to the company's $12/share in cash due to fears that management may waste the cash on a dilutive acquisition to replace the growth engine lost at the mobile business. Sandell noted that they were encouraged, however, by the company's statements that the company intends to do no such thing.
2. Net Operating Loss Carry-Forwards (NOLs) - These are assets that are frequently missed by investors in many companies - they are losses from past years that can be carried over to offset income taxes in future tax periods. The share price of INSP reflects virtually no value to the more than $1 billion in NOLs. Sandell attributed this to the fact that many investors are uncertain as to whether the company will be run for profitability or growth. With its current revenue and asset mix, management's lowest risk strategy would be to focus on maximizing profitability and selectively adding profitable cash flowing businesses that compliment the search/directories business. However, without an unrelenting focus on costs, this asset will be almost worthless.
3. Online - Sandell said that it believes that the true value of the online segment is being clouded by the confusing segment reporting and excessive corporate costs, which mask the true earnings power of this business. Moreover, concerns over growth prospects after last quarter's revenue declines likely added to this fact. The hedge fund insists that with better segment disclosure and a return to positive top line growth should result in at least a 40% EBITDA margin if it were run at optimal efficiency.
4. Mobile - Sandell insists that the stock price implies that investors are assigning zero value to this business even though there is still a stable core business outside of the affected content/ringtone business. Further, they believe that this segment should be a very attractive acquisition candidate due to its strategic positioning with the major mobile carriers and believe that InfoSpace should investigate the possibility of divesting this business.
   

So, what exactly does the hedge fund suggest? Well, they outlined two key elements in their letter to the company's Board of Directors:

1. Reduce expenses by at least $15 million through the end of 2007, which should add up to $5 of incremental value to the stock. While the company is currently working on cost cutting in its mobile division, the hedge fund said it would like to see this applied to the entire enterprise. Specifically, many of the expenses present in these areas are likely legacy expenses inherited from a time when INSP was a much larger company.
   
2. Buy back $200 million of its common stock through a Dutch tender offer at a premium to the current market price along with a $100 million special dividend. Sandell believes that these actions would not have any negative impact on the company's ability to utilize their NOLs going forward. Moreover, they believe that the two actions would send a very positive signal to the market that the company feels the problems of the past year are behind it and that management and the board are focused on enhancing shareholder value.

Clearly, Sandell makes a compelling argument for taking action to unlock shareholder value. They estimate that the company could be worth around $35 per share in the event of a simply restructuring and up to $41 per share in the event of a breakup. Sandell also stated that if the company did not heed these changes, they should hire an investment banker to pursue other strategic alternatives, which could include a possible sale of the company's various divisions. Combined, these factors definitely make INSP a stock worth watching closely!

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