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Why is This Hedge Fund Manager Betting Big on BluePhoenix?

Earlier today, Prescott Group Capital Management, Phil Frohlich’s fund, filed an amended Schedule 13D with the SEC, stating that its stake in BluePhoenix Solutions, Ltd. (NASDAQ:BPHX) had increased to 24.2%. The move brought Frohlich’s total holdings of the IT software company to nearly 2.5 million shares worth a little over $8.3 million. In the fund’s most recent 13F filing with the SEC at the end of last quarter, it reported a much smaller $4.1 million position in BluePhoenix. Including its most recent purchase, Prescott Group Capital Management has increased its holdings of BluePhoenix by 166.1% since March 31st.

Since this date, shares of the company have generated a spectacular return, popping 110.1% in a little over five months’ time. As expected, this appreciation has been much more impressive than many of its peers in the software application industry, most notably International Business Machines Corp. (NYSE:IBM) at -2.3%, Oracle Corporation (NASDAQ:ORCL) at 10.6%, Infosys Ltd ADR (NASDAQ:INFY) at -19.2%, and Tibco Software Inc. (NASDAQ:TIBX) at 1.5%.

International Business Machines Corp. (NYSE:IBM)

Despite these gains, shares of BluePhoenix still appear to be undervalued, as they trade at Price-to-Book (2.6X) and Price-to-Sales (0.7X) ratios below industry norms (4.1X, 3.8X). Moreover, the company’s book valuation is also below its aforementioned competitors, including International Business Machines (11.4X), Oracle (3.6X), Infosys (4.3X), and Tibco Software (6.5X). Additionally, BluePhoenix is trading at a modest Enterprise Value-to-Revenue ratio of 0.8X, below the likes of International Business Machines (2.4X), Oracle Corporation (3.9X), Infosys (3.2X), and Tibco Software (5.0X).

Interestingly, the company currently sports a Price-to-Cash Flow ratio (10.6X) below the industry average (16.8X), and its own 5-year (15.8X) and 10-year (22.6X) historical averages. In fact, over the past decade, BluePhoenix’s cash hoard has traditionally traded at a 124% premium above the S&P 500. At its current levels, the stock is much cheaper, trading at just a 16% premium.

From an earnings standpoint, the IT software company has experienced less than satisfactory EPS growth over the past five years (-34.9%), but expects its earnings to improve going forward at a rate of 15.0% a year over the next half-decade. If these estimates hold, fairly valued shares of BluePhoenix have a shot at continuing their superb rates of price appreciation.

Insider Monkey’s database shows that another BluePhoenix bull is Lake Union Capital Management, a Seattle-based investment advisory firm with assets under management slightly below $100 million. Earlier this year, the firm purchased 3,000 shares of the company to increase its holdings to 711,942 shares, a total that is currently worth almost $2.4 million. While this position is significantly smaller than Prescott Group Capital Management’s, it is still important to track these transactions.

Empirical research has shown that ardent hedge fund mimickers, or “monkeys,” can beat the market by as much as 7% a year, while our research has revealed several quantitative strategies that were able to beat the market by as much as 20% per annum between 1999 and 2008. Check out our Hedge Fund Education Center to learn more.

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