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Now's the Time to Buy Stocks of Cash-Rich Companies

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A closer look at IAC/InterActiveCorp, Liberty Starz Group, and Heelys.

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Editor's Note: Michael Brush is the editor of the stock newsletter Brush Up on Stocks and a weekly market columnist for MSN Money.

One way to make money in the market while protecting against downside in these uncertain times is to go with stocks that have lots of cash. Bloated cash cows offer three advantages.

Their huge cash hoards can serve as:

1. A signal that a company will actually follow through on a large announced share buyback plan, as in the case of IAC/InterActiveCorp (IACI) and Liberty Starz Group (LSTZA);

2. A cushion against excessive downside in a stock, giving speculators breathing room when shorting puts, which seems like a reasonable action plan with IAC/InterActiveCorp and Liberty Starz Group;

3. A backstop that gives management room to fix the business, and offers investors some protection against further downside especially when cash just about equals the current market cap, as in the case of Heelys (HLYS).

Here's a closer look at all three of these, and some potentially promising ways to play them.

IAC/InterActiveCorp

IAC/InterActiveCorp is a collection of Internet properties, including the popular dating site Match.com, Ask.com, Citysearch, and ServiceMagic, a home repair site. Match.com is profitable, if not a rapid grower, while Ask.com also brings in decent revenue with help from Google (GOOG), its partner in search-related online ad display. Many of this company's online businesses have seen solid revenue growth as the economy and advertising have picked up.

Even if growth is less than spectacular going forward and IAC/InterActiveCorp continues to lose money, its shares should get support as the company keeps deploying more cash to purchase huge amounts of its own stock.

"They are very aggressive buyers," says David Fried, of Fried Asset Management, which picks stocks in part by favoring companies that actually follow through on buyback plans. Since 2008, the company has spent nearly $1 billion to buy back about 36% of its shares outstanding. It now has plans to purchase another 10%, says Fried. Deutsche Bank analyst Jeetil Patel thinks the company could buy back another $1 billion in stock, or 35% of its share base, over the next 12 months.

That offers some downside protection, but here's another way to look at this company. Morningstar values the company's businesses at $6 a share, and it has about $14 a share in cash. So theoretically, at least, this suggests moves much below $20 shouldn't last too long.

Because you have this protection -- and there are concerns about growth -- I'd play this one by betting against downside, as opposed to betting on upside. To do so, I'd short the December or January $25 puts, or the January $22.50 puts, and collect the cash. Even if the market tumbles and this stock gets put to you, it's likely to rebound enough so you can get out -- unless CEO Barry Diller gets tempted by all that cash to make a dumb acquisition, which is one of the risks here.

Liberty Starz Group

Liberty Starz Group is another John Malone tracking stock that represents assets like the Starz and Encore cable movie channels -- plus $1.1 billion in cash, or about $18 a share. With the stock recently trading for $67.50, investors are vastly undervaluing Starz and Encore, which have a combined 48 million subscribers. A $500 million share buyback plan should also help support the stock.

Meanwhile, a catalyst on the horizon could be the a renegotiation of a streaming video rights deal that Starz has with Netflix (NFLX). Starz, which has the valuable digital distribution rights to Marvel and Pixar films from Disney (DIS), gets $25 million a year from Netflix for those digital streaming rights. This seems far too low, given that Netflix reportedly signed a digital distribution deal recently with Epix channel for $250 million a year. Liberty Starz could get considerable upside for Starz when it renegotiates its own deal with Netflix at some point soon.

For this one, I'd go with either buying the stock, or selling the November, December, or January $65 puts, but you'll likely have to accept the bid price rather than split the bid and ask with limit orders, because there's minimal volume in these options.

Heelys

Heelys, those shoes with wheels made by the company with the same name, were all the rage five years ago. But soon after the company came public in 2007, retailers found themselves overstocked with Heelys as the economy turned sour and sales declined. Despite price cuts, retailers had trouble clearing out inventory, so their purchases of more Heelys from the company dried up. The company's stock fell dramatically, trading recently for $2.70 a share, from $40 just after its initial public offering.

Now, the company is under new management. It's rolling out new products like the HX2, a Heely with two wheels for beginners, and the Nano, a small skateboard that attaches to your shoe. It's also taking steps to make bigger forays into Asian markets.

Any success that might come out of this is going to take time. But with cash levels of about $68 million, or about $6 million below the current market cap, you're getting some significant downside protection if you buy the stock now. And you're also just about getting the business "for free." Cash works out to about $2.40 a share, and the stock recently sold for $2.70. This stock is a favorite of Eric Marshall, co-portfolio manager of the Hodges Small Cap Fund (HDPSX), which is up 28% in the past year, or 13 percentage points more than the average small-cap fund. That doesn't guarantee Heelys stock will glide higher. But it's a nice signal in the background.

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No positions in stocks mentioned.

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