Activist investing takes places in even the largest multinational firms, as was the case with Bill Ackman of Pershing Square Capital Management, who forced McDonald’s (MCD) to make vital changes to its menu, improve customer service and realize hidden real estate value, all of which ultimately led to a doubling in McDonald’s stock price.

Another large multinational firm engaged with an activist investor is Yahoo! (YHOO). Now-board-member Carl Icahn has so far been unsuccessful in his attempts to get Yahoo! to sell its search business -- or even the entire company -- to Microsoft (MSFT).

But sometimes the activist investor isn't just another hedge fund. Take GSI Group (GSIG). Stephen W. Bershad, the CEO of Axsys Technologies (AXYS), put his own capital on the line when he recently bought 3.3 million shares of GSI Group in the open market.

Last week, Bershad filed a 13D, or an "activist" filing, because he has acquired 7% of the company since late January, at around 75 cents or so per share.

This under-the-radar filing is fascinating, especially given Bershad’s position as a CEO of a major defense contractor and the industry connections, contacts and other personal scuttlebutt he must have access to as a result. Additionally, it is important that Axsys, which is located in Rocky Hill, Conn., is less than two hours away from GSI’s Bedford, Mass., headquarters. If Bershad is looking to extract more value from both companies, their proximity makes that much more convenient.

GSI has had some trying times lately. Accounting irregularities, acquisitions and a complex balance sheet make this company complex to value. Investors hate accounting errors and duly punished the stock, sending it from $9 to less than $1 per share.

However, the beauty of activist investing is we can follow the smart money. According to recent SEC filings by Bershad last week, he purchased the GSI Group shares because he believes they "represent an attractive investment opportunity.” Also according to the filing, on Feb. 3, Bershad met with President and CEO Gergio Edelstein at the GSI offices to discuss Bershad's interest in GSI Group.

GSI is in a related industry to Axsys, so we know that Bershad has some familiarity with GSI's end markets. GSI operates, manufactures and ultimately sells several product lines, including galvo motors, optical scanners, scan heads and resonant scanners. Two summers ago, GSI’s galvanometer played a critical role in delivering detailed images of NASA’s Discovery spaceship, helping to identify potentially dangerous cracks in the ship's heat shield.

In the third quarter of 2008, GSI bought out Excel Technology for roughly $300 million. Excel Technologies is the leading designer and manufacturer of precision motion component products, lasers and laser systems.

2007 revenue for Excel Technology of $160 million with adjusted EBITDA of $23.9 million which equates to 15% gross margins, slightly higher than the industry average of 10% or so. Second-quarter 2008 results for Excel Technology, which is the last public filing by the company before the merger agreement, showed that on a quarterly basis, earnings per share were up 13.5% at 42 cents, vs. 37 cents for the second quarter of 2007.

For full-year 2007 GSI and Excel reported sales of $478 million, which is third in the industry behind Coherent (COHR) and Rofin-Sinar (RSTI).

On Dec. 4, 2008, GSI Group said that it will restate its financial results for the first and second quarters of fiscal 2008 after it found errors in accounting for revenue. As a result, GSI’s CEO and CFO were forced to resign. Former Vice President and CFO Robert Bowen has already accepted an offer from Abiomed (ABMD).

GSI is in the process of reviewing its audit and plans to restate earnings shortly. It's important to keep in mind that the company is restating only about $20 million in revenue.

It's also interesting to note that on Feb. 11, GSI filed an 8K with the SEC stating that on Feb. 6 it entered into a forbearance agreement with certain beneficial owners of GSI. Ultimately, as part of the forbearance agreement, GSI Grop will "retain the services of a financial advisor by no later than February 20, 2009.” This tells us that the bond holders are willing to take a back-seat in their preferred status so long as GSI Group retains a financial advisor -- presumably to sell the company.

The financials here are complex, but in all likelihood, GSI will earn $200 million in 2009, which is at the low end of estimates. Taking into account its $80 million in cash, $200 million in debt and 50 million shares outstanding, that's an intrinsic value of $1.60 per share. Factor in valuation on a per-segment basis, and it could be as high as $3. (This also does not factor in any of Excel’s business, which could add an additional $1 per share.)

Recently, in Friday morning trading, the stock was at about $1.

As for Bershad, he's got Wall Street cred. Over the past five years, shares of Axsys are up more than 300% vs. a decline in the S&P 500 of 45%. From 2004 to 2007, net sales went from $78.2 million to $171.6 million, while operating income went from just $6.8 million to $23.3 million. Overall, the firm’s backlog, which is a measure of existing orders vs. current production levels, grew from $75.6 million to $140.2 million from 2004 to 2007.

If the CEO of Axsys is taking a harder look at GSI Group, so should you.

Posted on Feb. 13, 2009