Seahawk Drilling is an interesting company that has received ample press around the blogosphere. Greenbackd has an excellent series of posts covering the background, possible downside from taxes , and done an in depth look at the valuation of the company's rigs, which becomes a de facto liquidation value. I don't have much to add on the background of the stock. I'd just like to look at the recent developments, because the stock has been moving even lower in recent weeks.
First of all, this stock is such a classic example of what Wall Street hates. Natural gas pricing is down, there's risk in government regulation, HAWK is a spinoff, a lack of profits makes earnings based valuations difficult, and most importantly shallow water drilling is not nearly as sexy as deepwater drilling. This company just can't seem to get a break.
Second, as much as a psychological gut reaction is to be repulsed by the stock, looking at the liquidation value and cash burn still gives investors time for the company to turn the corner. Due to a good portion of the rigs being cold stacked (in minimal cash burning state) and having shown a willingness to sell rigs, the company has flexibility going forward.
Other than time passing and more cash being burned, I believe that the canceled sale of a rig has been a drag on the stock. The company has taken money out on its credit facility. The company has some pending contracts for work, although a large amount number of rigs are not making money. The balance sheet has only gotten messier as the company has tried to manage its cash flow and taken on some debt.
While the cancellation of the rig sale is a negative, I'd like to look at the silver lining. Most importantly, the cancellation of the rig sale was a result of the purchaser failing to get the contract that the purchase of the rig was contingent on. While this does mean the company will have to continue to look for ways to generate cash, it clearly indicates the company is doing what it can to remain in operation.
In a previous post, I discussed the upside case for natural gas presented by Ken Peak of Contango Oil & Gas. Natural gas pricing does play a role in the upside of HAWK as well, but the downside is well protected by the value of the rigs. Since the company has so far shown that it is willing to sell off assets to remain afloat, the company is not responding in a flat footed fashion. While there is some worry that it might not be able to execute on attempts to sell rigs, that the company has gotten more work for some of its rigs indicates that a market exists for the services.
Long HAWK, do your own research before investing
Talk to Andrew about Seahawk Drilling
Monday, January 31, 2011
Wednesday, January 26, 2011
Ruminations on the conglomerate discount of Loews
Loews Corporation, run by the Tisch family, has often been compared to a baby Berkshire alongside Brookfield Asset Management or Markel. The company owns outright or stakes in several companies, both public and private. As often seen with this type of corporate structure, a conglomerate discount is applied and the stock can look attractive on a sum-of-the-parts basis.
A brief summary of the holdings can be found here.
The company is well aware of the discount, which has been persistent over the years. The company is a perpetual buyer of its own stock on the open market. From 2007 to the most recent quarter, just under 25% of the shares outstanding have been repurchased.
As for the unlisted components of the stock, the hotel portfolio is carried at book value, but the real estate values have grown immensely since their purchase. The natural gas acreage via the Highmount Exploration subsidiary has also shown promise and JVs and purchases have been undertaken by others in the same field. There are also unlisted securities in the companies that are listed: CNA preferred stock, Boardwalk Class B units and some Boardwalk debt.
The stock has been featured in Barron’s, Value Investor’s Club, and numerous blogs. I have very little to add from a quantitative analysis standpoint, but I have some ruminations about the discount and why it should close.
I would classify the conglomerate discount under two different types dynamics. First is a holding company, where a parent holds stakes in companies. In such cases, GAAP earnings can be convoluted because the earnings do not actually pass up to the parent. From a real world perspective, the parent transitively benefits from the earnings being reinvested at the company level and increasing the value of the stake. The stock market does not seem to be a big fan of such a structure, as it inhibits realization of underlying value.
The other dynamic of conglomerate discounts seems to be companies with unrelated segments, some boring some sexy. Even though earnings go straight through the parent company, a discount is still applied because the earnings might not be optimally reinvested or a stagnant segment obscures an attractive one.
When I think of Loews, it falls vaguely under the former classification. At the same time, what is actually occurring at Loews is not typical of such operations. A lot of the earnings from BWP and DO make their way into the parent through dividends, which are fairly close to the earnings of those stakes due to the limited reinvestment needs of a rig operator and the MLP structure of BWP.
Loews has acted responsibly in the past to minimize tax implications of their moves to increase shareholder value. The Lorillard spinoff was done in a way that resulted in no taxes being paid. In the instance of the shares of BWP and DO, the way to fully realize their value is through receiving the dividend checks every quarter, as opposed to liquidating the holdings as taxes on such a sale would represent a pretty penny as Loews has held these assets for years. So for the very reason that I suspect the market is applying a discount to net asset value of the company, I am inclined to fairly value them as the status quo is resulting in the full realization of their value.
The crucial factor to recognize, other than the one just stated, is that Loews has consistently increased its value over time. Repurchasing its shares at a discount is additional gravy on top of the discount, because it only widens the disparity of per share value and price. That the price has not followed or that the discount has existed in the past is not relevant to the ultimate value of the company. The company’s actions have consistently exhibited all the characteristics of excellent capital allocation and maximization of shareholder value and patient investors will be rewarded.
Disclosure: Long Loews. Do your own research before making investment decisions.
Talk to Andrew about Loews and conglomerate discounts
A brief summary of the holdings can be found here.
The company is well aware of the discount, which has been persistent over the years. The company is a perpetual buyer of its own stock on the open market. From 2007 to the most recent quarter, just under 25% of the shares outstanding have been repurchased.
As for the unlisted components of the stock, the hotel portfolio is carried at book value, but the real estate values have grown immensely since their purchase. The natural gas acreage via the Highmount Exploration subsidiary has also shown promise and JVs and purchases have been undertaken by others in the same field. There are also unlisted securities in the companies that are listed: CNA preferred stock, Boardwalk Class B units and some Boardwalk debt.
The stock has been featured in Barron’s, Value Investor’s Club, and numerous blogs. I have very little to add from a quantitative analysis standpoint, but I have some ruminations about the discount and why it should close.
I would classify the conglomerate discount under two different types dynamics. First is a holding company, where a parent holds stakes in companies. In such cases, GAAP earnings can be convoluted because the earnings do not actually pass up to the parent. From a real world perspective, the parent transitively benefits from the earnings being reinvested at the company level and increasing the value of the stake. The stock market does not seem to be a big fan of such a structure, as it inhibits realization of underlying value.
The other dynamic of conglomerate discounts seems to be companies with unrelated segments, some boring some sexy. Even though earnings go straight through the parent company, a discount is still applied because the earnings might not be optimally reinvested or a stagnant segment obscures an attractive one.
When I think of Loews, it falls vaguely under the former classification. At the same time, what is actually occurring at Loews is not typical of such operations. A lot of the earnings from BWP and DO make their way into the parent through dividends, which are fairly close to the earnings of those stakes due to the limited reinvestment needs of a rig operator and the MLP structure of BWP.
Loews has acted responsibly in the past to minimize tax implications of their moves to increase shareholder value. The Lorillard spinoff was done in a way that resulted in no taxes being paid. In the instance of the shares of BWP and DO, the way to fully realize their value is through receiving the dividend checks every quarter, as opposed to liquidating the holdings as taxes on such a sale would represent a pretty penny as Loews has held these assets for years. So for the very reason that I suspect the market is applying a discount to net asset value of the company, I am inclined to fairly value them as the status quo is resulting in the full realization of their value.
The crucial factor to recognize, other than the one just stated, is that Loews has consistently increased its value over time. Repurchasing its shares at a discount is additional gravy on top of the discount, because it only widens the disparity of per share value and price. That the price has not followed or that the discount has existed in the past is not relevant to the ultimate value of the company. The company’s actions have consistently exhibited all the characteristics of excellent capital allocation and maximization of shareholder value and patient investors will be rewarded.
Disclosure: Long Loews. Do your own research before making investment decisions.
Talk to Andrew about Loews and conglomerate discounts
Monday, January 24, 2011
Should Helen of Troy (HELE) be the company that launches a thousand buy orders?
Helen of Troy is a diversified producer of brand name products that generates tons of cash but trades at a low price. The company can be purchased at 10x TTM earnings and 8.5x projected earnings with a safe balance sheet and a business that can continue to earn in any economic climate. While top line growth is a product of acquisitions, the bottom line has steadily increased over the years.
Sales and earnings were $300m and $17m respectively in 2000. By 2010, they have grown to $650m and $71m. While sales just over doubled, profits quadrupled. Most of the progress happened from 2000-2004. From 2005-2010, sales have hovered between $581m and $652m and profits between $49m and $76m. The company’s fiscal year ends in February, so Fiscal 2009, when the company earned $49m excluding an impairment, includes most of the carnage of the recession. From 2005-2010, the company averaged $59m a year in net income. The company is a tremendous generator of FCF though, spending an annual average of $7m on capex in the past 3 years, while recording depreciation of $15m. The growth of the company has come from acquisitions, which leads to pessimism from Wall Street analysts. The company has not been a rip-roaring growth story, but the acquisitions have worked out a lot more times than not.
The crown jewel of this company is OXO, a strong brand the that produces a lot of kitchen related products and is expanding product offerings. The company has been releasing more than 100 new products a year under this brand and being growing sales and profits. They are expanding into childcare products such as strollers this year. The things that should be taken away from this division are that it shows how the company is good at developing brands and products (they bought OXO in 2004 and have done a tremendous job in growing it). The growth rate has been slowing lately to the high single digits, but the segment has the best margins.
Peter Lynch, among other investors, will tell you to buy what you know. I’m familiar with the OXO brand from a few kitchen tools like spatulas or peelers and think the brand definitely has a lot of power and can be expanded. While people may only buy one pizza cutter, a positive experience will resonate and carry over to their plastic containers or garden tools for instance.
The other division of the company is personal care products that range form hair dryers to foot baths and shampoo. The company has long term licenses to brands or outright owns brands that it puts on a variety of goods you can find in pharmacies or stores like Target and Walmart. For instance, they have a license for the Dr. Scholl’s brand name for foot baths. They are able to sell a relatively simple product, but piggyback on the visibility of the brand recognition to drive sales, acquire shelf space, and gain a degree of pricing power.
There are other brands the personal care division represents, but there is a similar dynamic to the housewares division. The company tries to continually release new products and updates under these brands. The brands have huge mindshare of customers, and HELE’s products benefit from the positive association. The brand name owners have to approve the products as well, so the company is going to consistently release products that remain relevant to the brand and fully leverage its strengths.
What the market seems to fail to recognize is that while maybe the personal care segment is boring, the houseware segment is pretty valuable:
The houseware segment has better margins and plenty of growth lies ahead. The growth has slowed and this has analysts worried that the stock is now dead money. Both segments generate plenty of cash though, which the company has been reinvesting in bolt on acquisitions. In 2010, the company acquired Pert Plus and Sure for $69m from Innovative Brands (the company should earn ~12m in 2010, $9m for the company due to the timing of the acquisition) and Kaz for $265m from the founding family and a private equity group. Kaz is of the same breed as Helen of Troy, using brands such as Vicks on humidifiers it sells. In 2009, the company acquired Infusium shampoos from Procter & Gamble for $60m. All these acquisitions are immediately accretive to earnings, expand the company’s offerings, and leverage the company’s relationship with customers.
The last part about leveraging the company’s relationship is key. It is a reinforcing mechanism, because the large companies (Walmart, Target, CVS, Walgreens) prefer to deal with fewer suppliers. In 2003, Walmart accounted for 30% of sales. Now it only accounts for 20% of sales. It’s largest 5 customers account for 45% of sales. Once the company gains a foothold on a store’s shelves, it can start pushing other products onto shelves as well, expanding its revenue base. As the company acquires more brands, it can fill in any gaps in their distribution or its own. As with Infusium, it can pay more attention to a $60m brand than P&G will, further wringing out sales that could only be realized if the brand was separated from P&G. The acquisitions are also done at good prices.
Kaz has the Vicks and Honeywell brand names for products, along with a few others. The Honeywell name has great recognition and signifies quality, and so throwing it on a machine like a fan gives people more confidence than if it said “Frog’s Kiss Fans” on it. Kaz is very much in line with the company’s business and operations, and there are real cost cutting opportunities that can be achieved such as consolidating regional offices and distribution.
Kaz gives the company a greater foreign footprint, further diversifies the product lines, and was done at a price of 7x adjusted EBITDA (this is the figure the company gives) while the company trades at around 9x EBITDA. I think the acquisition will be successful and the company’s past history or acquisitions has been a net positive.
The acquisition of Kaz boosted the company from having a small net debt position, to around $260m net debt. The company has proven fairly stable and has under a 3x debt/TTM EBITDA ratio, which is manageable and not excessive. Kaz should boost cash flow as well, and the company has forecasted a $0.50 increase in EPS for 2011 to $3.50. This is mostly, if not all, attributable to the Kaz acquisition. Even trimming down managements forecast to $3/share puts the current value at less than 10x earnings.
The CEO has been running the company for years and owns 1.6m shares worth around $45m, so the company is in reliable and properly incentivized hands. The CEO recently sold 40,000 shares, but I don’t take this negatively. The CEO still owns a huge block of shares and the reasons for selling can be plentiful.
A very crude 10 year DCF having the company have no growth and generate $100m in FCF with an exit multiple of 6x FCF of $100m values the company at $1.1B NPV. The past record of success indicates that any FCF reinvested in the business will be done so wisely. The company is currently trading as if it will generate $75m in FCF annually and sell out for a 6x FCF of $75m in 10 years. Barring any huge economic shocks like those seen in 2008, the company is operating at a level that earns well over this hurdle.
The major risk is commodity prices. The company is exposed to copper and oil due to the electrical components, chemicals, and packaging. The company’s production is mostly in the Far East, which can prove problematic if transportation rates increase. The company has never had its profits wiped out by commodity prices in 2007 and 2008, so the risk is more in dampened earnings than a dangerous scenario where the company loses money.
The company is a straightforward value stock in my opinion. The company is throwing off cash that it has been successfully reinvesting in acquisitions. At 10x earnings, the market seems to expect the company to make no money on its recent acquisitions despite a long history of profitability (absent the 2009 goodwill impairment), integrating acquisitions, and sound management. Conventional metrics of earnings and a crude DCF model indicate that the market expects very little positives to occur, and seems to expect negative news. The company is involved in an easy to understand business that faces little obsolescence risk and should continue to generate strong cash flows to protect investors on the downside.
Disclosure: Long HELE. Do your own research before investing.
Talk to Andrew about HELE
Sales and earnings were $300m and $17m respectively in 2000. By 2010, they have grown to $650m and $71m. While sales just over doubled, profits quadrupled. Most of the progress happened from 2000-2004. From 2005-2010, sales have hovered between $581m and $652m and profits between $49m and $76m. The company’s fiscal year ends in February, so Fiscal 2009, when the company earned $49m excluding an impairment, includes most of the carnage of the recession. From 2005-2010, the company averaged $59m a year in net income. The company is a tremendous generator of FCF though, spending an annual average of $7m on capex in the past 3 years, while recording depreciation of $15m. The growth of the company has come from acquisitions, which leads to pessimism from Wall Street analysts. The company has not been a rip-roaring growth story, but the acquisitions have worked out a lot more times than not.
The crown jewel of this company is OXO, a strong brand the that produces a lot of kitchen related products and is expanding product offerings. The company has been releasing more than 100 new products a year under this brand and being growing sales and profits. They are expanding into childcare products such as strollers this year. The things that should be taken away from this division are that it shows how the company is good at developing brands and products (they bought OXO in 2004 and have done a tremendous job in growing it). The growth rate has been slowing lately to the high single digits, but the segment has the best margins.
Peter Lynch, among other investors, will tell you to buy what you know. I’m familiar with the OXO brand from a few kitchen tools like spatulas or peelers and think the brand definitely has a lot of power and can be expanded. While people may only buy one pizza cutter, a positive experience will resonate and carry over to their plastic containers or garden tools for instance.
The other division of the company is personal care products that range form hair dryers to foot baths and shampoo. The company has long term licenses to brands or outright owns brands that it puts on a variety of goods you can find in pharmacies or stores like Target and Walmart. For instance, they have a license for the Dr. Scholl’s brand name for foot baths. They are able to sell a relatively simple product, but piggyback on the visibility of the brand recognition to drive sales, acquire shelf space, and gain a degree of pricing power.
There are other brands the personal care division represents, but there is a similar dynamic to the housewares division. The company tries to continually release new products and updates under these brands. The brands have huge mindshare of customers, and HELE’s products benefit from the positive association. The brand name owners have to approve the products as well, so the company is going to consistently release products that remain relevant to the brand and fully leverage its strengths.
What the market seems to fail to recognize is that while maybe the personal care segment is boring, the houseware segment is pretty valuable:
The houseware segment has better margins and plenty of growth lies ahead. The growth has slowed and this has analysts worried that the stock is now dead money. Both segments generate plenty of cash though, which the company has been reinvesting in bolt on acquisitions. In 2010, the company acquired Pert Plus and Sure for $69m from Innovative Brands (the company should earn ~12m in 2010, $9m for the company due to the timing of the acquisition) and Kaz for $265m from the founding family and a private equity group. Kaz is of the same breed as Helen of Troy, using brands such as Vicks on humidifiers it sells. In 2009, the company acquired Infusium shampoos from Procter & Gamble for $60m. All these acquisitions are immediately accretive to earnings, expand the company’s offerings, and leverage the company’s relationship with customers.
The last part about leveraging the company’s relationship is key. It is a reinforcing mechanism, because the large companies (Walmart, Target, CVS, Walgreens) prefer to deal with fewer suppliers. In 2003, Walmart accounted for 30% of sales. Now it only accounts for 20% of sales. It’s largest 5 customers account for 45% of sales. Once the company gains a foothold on a store’s shelves, it can start pushing other products onto shelves as well, expanding its revenue base. As the company acquires more brands, it can fill in any gaps in their distribution or its own. As with Infusium, it can pay more attention to a $60m brand than P&G will, further wringing out sales that could only be realized if the brand was separated from P&G. The acquisitions are also done at good prices.
Kaz has the Vicks and Honeywell brand names for products, along with a few others. The Honeywell name has great recognition and signifies quality, and so throwing it on a machine like a fan gives people more confidence than if it said “Frog’s Kiss Fans” on it. Kaz is very much in line with the company’s business and operations, and there are real cost cutting opportunities that can be achieved such as consolidating regional offices and distribution.
Kaz gives the company a greater foreign footprint, further diversifies the product lines, and was done at a price of 7x adjusted EBITDA (this is the figure the company gives) while the company trades at around 9x EBITDA. I think the acquisition will be successful and the company’s past history or acquisitions has been a net positive.
The acquisition of Kaz boosted the company from having a small net debt position, to around $260m net debt. The company has proven fairly stable and has under a 3x debt/TTM EBITDA ratio, which is manageable and not excessive. Kaz should boost cash flow as well, and the company has forecasted a $0.50 increase in EPS for 2011 to $3.50. This is mostly, if not all, attributable to the Kaz acquisition. Even trimming down managements forecast to $3/share puts the current value at less than 10x earnings.
The CEO has been running the company for years and owns 1.6m shares worth around $45m, so the company is in reliable and properly incentivized hands. The CEO recently sold 40,000 shares, but I don’t take this negatively. The CEO still owns a huge block of shares and the reasons for selling can be plentiful.
A very crude 10 year DCF having the company have no growth and generate $100m in FCF with an exit multiple of 6x FCF of $100m values the company at $1.1B NPV. The past record of success indicates that any FCF reinvested in the business will be done so wisely. The company is currently trading as if it will generate $75m in FCF annually and sell out for a 6x FCF of $75m in 10 years. Barring any huge economic shocks like those seen in 2008, the company is operating at a level that earns well over this hurdle.
The major risk is commodity prices. The company is exposed to copper and oil due to the electrical components, chemicals, and packaging. The company’s production is mostly in the Far East, which can prove problematic if transportation rates increase. The company has never had its profits wiped out by commodity prices in 2007 and 2008, so the risk is more in dampened earnings than a dangerous scenario where the company loses money.
The company is a straightforward value stock in my opinion. The company is throwing off cash that it has been successfully reinvesting in acquisitions. At 10x earnings, the market seems to expect the company to make no money on its recent acquisitions despite a long history of profitability (absent the 2009 goodwill impairment), integrating acquisitions, and sound management. Conventional metrics of earnings and a crude DCF model indicate that the market expects very little positives to occur, and seems to expect negative news. The company is involved in an easy to understand business that faces little obsolescence risk and should continue to generate strong cash flows to protect investors on the downside.
Disclosure: Long HELE. Do your own research before investing.
Talk to Andrew about HELE
Sunday, January 23, 2011
Could an ordinary investor have predicted these acquisitions?
The post reorganization equity is a field for investments that I have visited before, and consider one of the more attractive fields to search for gems. The attractiveness is outlined in Joel Greenblatt’s book. The reason I am writing this post is because Smurfit-Stone, a company that recently emerged from bankruptcy, just agreed to be bought by RockTenn.
When a company emerges from bankruptcy, it is typically much leaner from a fixed cost perspective. Wages can be lowered, debt can be erased, and agreements with suppliers or customers can be amended. This is why contrary to conventional wisdom, a company becomes more attractive after it declares bankruptcy. As Greenblatt outlines, there are many examples of this occurring, and Smurfit-Stone can now be added to the list.
Another interesting aspect of the acquisition is that Footnoted over at Morningstar released a report on potential acquisitions in 2011. Can you guess one of the companies on that last? Yes, Smurfit-Stone. Footnoted uses a different methodology to arrive at this conclusion, utilizing a close reading of nuances in SEC filings. Footnoted and Morningstar each chose their top 10 potential acquisition targets which can be found here and here respectively. The Footnoted report is more in depth and their thought process is more fleshed out and readers can learn by reverse engineering their process. I recommend this to anyone looking for a jumping point in research. Looking for companies on the lists that are cheap regardless of their buyout potential gives someone a catalyst to point to for unlocking value.
The New York Times ran an article in the Sunday Business section about Citadel Broadcast being sought by another company. This is another example of a company emerging from bankruptcy and being a much more attractive company. This instance is a little more fraught with controversy as the article outlines. What the article doesn’t really delve into is that most of the new shareholders were former debt holders. They are looking to cash out as soon as possible. Their selling normally pushes the price down even greater, as they are less concerned with the value of the stock. In this case, the buyout offer has given former debtholders the opportunity to sell without driving down the price in the process. At the same time, this situation should act as a warning that investors should be looking for companies they would like to own even if it is not acquired.
I hope these few examples demonstrate that there is almost always the catalyst of an acquisition in the post reorg equity space. If you buy a company cheap enough, as these usually are, it become icing on the cake. There are still plenty of bankruptcies getting worked through that are going to start trading soon enough, and I posted a link to a list of potential companies in this post.
To answer the title of the post, I don't think an investor could predict these acquisitions. Footnoted is quite the thorough investigator. I do strongly believe that an investor can put themselves in a situation - post reorg equities - where the chance of an acquisition is higher than other stocks, and plenty of resources exist for investors to find worthy investments in such circumstances.
Talk to Andrew about post reorg equities
When a company emerges from bankruptcy, it is typically much leaner from a fixed cost perspective. Wages can be lowered, debt can be erased, and agreements with suppliers or customers can be amended. This is why contrary to conventional wisdom, a company becomes more attractive after it declares bankruptcy. As Greenblatt outlines, there are many examples of this occurring, and Smurfit-Stone can now be added to the list.
Another interesting aspect of the acquisition is that Footnoted over at Morningstar released a report on potential acquisitions in 2011. Can you guess one of the companies on that last? Yes, Smurfit-Stone. Footnoted uses a different methodology to arrive at this conclusion, utilizing a close reading of nuances in SEC filings. Footnoted and Morningstar each chose their top 10 potential acquisition targets which can be found here and here respectively. The Footnoted report is more in depth and their thought process is more fleshed out and readers can learn by reverse engineering their process. I recommend this to anyone looking for a jumping point in research. Looking for companies on the lists that are cheap regardless of their buyout potential gives someone a catalyst to point to for unlocking value.
The New York Times ran an article in the Sunday Business section about Citadel Broadcast being sought by another company. This is another example of a company emerging from bankruptcy and being a much more attractive company. This instance is a little more fraught with controversy as the article outlines. What the article doesn’t really delve into is that most of the new shareholders were former debt holders. They are looking to cash out as soon as possible. Their selling normally pushes the price down even greater, as they are less concerned with the value of the stock. In this case, the buyout offer has given former debtholders the opportunity to sell without driving down the price in the process. At the same time, this situation should act as a warning that investors should be looking for companies they would like to own even if it is not acquired.
I hope these few examples demonstrate that there is almost always the catalyst of an acquisition in the post reorg equity space. If you buy a company cheap enough, as these usually are, it become icing on the cake. There are still plenty of bankruptcies getting worked through that are going to start trading soon enough, and I posted a link to a list of potential companies in this post.
To answer the title of the post, I don't think an investor could predict these acquisitions. Footnoted is quite the thorough investigator. I do strongly believe that an investor can put themselves in a situation - post reorg equities - where the chance of an acquisition is higher than other stocks, and plenty of resources exist for investors to find worthy investments in such circumstances.
Talk to Andrew about post reorg equities
Tuesday, January 18, 2011
Tim McElvaine - An investor I admire
Tim McElvaine is a Canadian value investor who I admire. He isn’t running a huge amount of money and the fund is only open to Canadians. I found out about him via ControlledGreed a while back and have followed him ever since. You can read more about him through media links on his own website. What I would specifically like to highlight is his ABBA investment strategy, which is essentially a Ben Graham strategy with additions similar to Seth Klarman or Warren Buffett in the 70s. I like to look at what each of the four letters stand for every time I need to regain my focus in analyzing a company. I recommend downloading the PDF version of the ABBA document and keeping it on your desk. It is a very good description at the variables that an investor should be further analyzing when looking at a business. It is a fantastic refresher every time I sit down.
McElvaine shares some investing picks on his website and simultaneously demonstrates the ABBA analysis. Being able to look at his method and what it produces is a good indicator of the quality of McElvaine’s investing ability, which I rate as very high. I find these two picks to be interesting. The first is Glacier Media, and the second is TimberWest Forest Corp. I don't have anything to add to his analysis, but I like what I have read.
Talk to Andrew about investors you admire (other than Andrew, of course)
McElvaine shares some investing picks on his website and simultaneously demonstrates the ABBA analysis. Being able to look at his method and what it produces is a good indicator of the quality of McElvaine’s investing ability, which I rate as very high. I find these two picks to be interesting. The first is Glacier Media, and the second is TimberWest Forest Corp. I don't have anything to add to his analysis, but I like what I have read.
Talk to Andrew about investors you admire (other than Andrew, of course)
Monday, January 17, 2011
CoSine Communications (COSN) update - making sure to get your money
I would like to thank Matt, a reader, as well as Tim Eriksen who pointed out on the SeekingAlpha copy of the article, that there is one further step necessary to receive money in lieu of shares of the post reverse-merger COSN mentioned in a previous post. One must be a "shareholder of record," as opposed to just a shareholder through a broker. If the shares are held through a broker, they do not qualify for the transaction. At this point since I am neither qualified, knowledgeable enough, or licensed to advise on this, I would point you to your broker who should be capable of sorting this out. This link sheds some light on the difference between a "shareholder of record" and a "beneficial owner of shares," which is what most retail investors fall under in their transactions. No date has been announced yet for the transaction, so there should be ample time for someone looking to take advantage of this opportunity to become a shareholder of record.
I appreciate any and all feedback, because as this instance has proven, it can save you and me both money.
Give Andrew more feedback
I appreciate any and all feedback, because as this instance has proven, it can save you and me both money.
Give Andrew more feedback
Thursday, January 13, 2011
Net 1 UEPS Technologies (UEPS) - Speculation or Investment?
Net 1 UEPS Technologies (UEPS) is a situation that is has both high risk and high uncertainty. There is plenty of upside in the company if a number of its initiatives succeed and its core business remains healthy. At this point in time, it is very uncertain and recent developments have increased the risk of a permanent loss of capital.
The business model of UEPS is phenomenal and should throw off free cash flow. Over the past years it has been a tremendous cash generator. From 2006-2010, the business earned an average of $45m a year (high of $86m and a low of $39m which includes a $37m impairment charge), usually maintaining a large portion of its market capitalization in cash. Its primary business is administering social benefits in several South African provinces, although it has a nascent project in Iraq and has been selling hardware to other African governments. It manufactures and distributes electronic readers and cards that create a network and charges transaction fees – a fundamentally similar business model to Visa or Mastercard.
Where it differs is that its survival is based on the South African Social Security Agency’s (SASSA) willingness to allow it to administer social benefits. The SASSA is looking to enact a nationwide system that would deal with only one business as opposed to the current 3. The bidding process has been mired in delays and the past years business has only resulted from 3 and 6-month extensions on their old contracts. The company recently reported that while it was previously expected to run out their extensions by March 31, 2011, a 6-month extension has been granted until September. The company has projected earnings of $1.50 if they maintain the contract for the year, and with the stock trading at $12/share, that is 8 times earnings for a company that requires little capital expenditures and could possibly become an entrenched network in South Africa.
UEPS has a potential moat in its technology that allows for off-the-grid and secure processing of payments – a major plus in a region of the world that can’t guarantee consistent power supplies – but the patents have been expiring and continue to expire 2010-2012. There is the potential to develop a network that achieves critical mass and becomes a necessity for different places of business in South Africa – a potentially profitable outcome, but speculative at this point. While UEPS administers benefits in the largest number of provinces, there are 2 other competitors, and it is possible they might be willing to implement UEPS's technology at a lower price. On the plus side, it has by far the largest position with >50% of the market and a presence in the most number of provinces. It is not guaranteed to become the sole provider of SASSA benefits.
I am not an expert on South African politics, but there appear to be wildcards in the bidding process stated in the company’s filings. As a result of the apartheid, the government follows the policy of Black Economic Empowerment (BEE), which means economic decisions can be heavily influenced a company’s management’s representation of different races. Factors like this make UEPS an investment that would require a substantial margin of safety in order to be a comfortable investment.
Up until recently, a big safety net for the company existed in a $200m net cash position, making up close to half the market capitalization. UEPS purchased a Korean payment processing company for $240m, not only erasing the cash position, but also adding to fixed costs through debt. While the Korean company may offer value, it may not have been the best use of cash in light of such uncertainty. The risk that the SASSA contact becomes worthless would leave the company dependent on the Korean business and the scraps of a couple nascent initiatives that have yet to gain traction, such as mobile banking – a field that has plenty of competitors. If the pre-merger business becomes worth very little – $0 for arguments sake – that leaves about $240m of value (the Korean business), while the company currently trades at a market capitalization of $540m. If the company can get the SASSA contract for the entire country, substantial upside exists, but there is ample downside to make purchasing the stock a speculative venture rather than an investment.
Disclosure: None
Talk to Andrew about UEPS
The business model of UEPS is phenomenal and should throw off free cash flow. Over the past years it has been a tremendous cash generator. From 2006-2010, the business earned an average of $45m a year (high of $86m and a low of $39m which includes a $37m impairment charge), usually maintaining a large portion of its market capitalization in cash. Its primary business is administering social benefits in several South African provinces, although it has a nascent project in Iraq and has been selling hardware to other African governments. It manufactures and distributes electronic readers and cards that create a network and charges transaction fees – a fundamentally similar business model to Visa or Mastercard.
Where it differs is that its survival is based on the South African Social Security Agency’s (SASSA) willingness to allow it to administer social benefits. The SASSA is looking to enact a nationwide system that would deal with only one business as opposed to the current 3. The bidding process has been mired in delays and the past years business has only resulted from 3 and 6-month extensions on their old contracts. The company recently reported that while it was previously expected to run out their extensions by March 31, 2011, a 6-month extension has been granted until September. The company has projected earnings of $1.50 if they maintain the contract for the year, and with the stock trading at $12/share, that is 8 times earnings for a company that requires little capital expenditures and could possibly become an entrenched network in South Africa.
UEPS has a potential moat in its technology that allows for off-the-grid and secure processing of payments – a major plus in a region of the world that can’t guarantee consistent power supplies – but the patents have been expiring and continue to expire 2010-2012. There is the potential to develop a network that achieves critical mass and becomes a necessity for different places of business in South Africa – a potentially profitable outcome, but speculative at this point. While UEPS administers benefits in the largest number of provinces, there are 2 other competitors, and it is possible they might be willing to implement UEPS's technology at a lower price. On the plus side, it has by far the largest position with >50% of the market and a presence in the most number of provinces. It is not guaranteed to become the sole provider of SASSA benefits.
I am not an expert on South African politics, but there appear to be wildcards in the bidding process stated in the company’s filings. As a result of the apartheid, the government follows the policy of Black Economic Empowerment (BEE), which means economic decisions can be heavily influenced a company’s management’s representation of different races. Factors like this make UEPS an investment that would require a substantial margin of safety in order to be a comfortable investment.
Up until recently, a big safety net for the company existed in a $200m net cash position, making up close to half the market capitalization. UEPS purchased a Korean payment processing company for $240m, not only erasing the cash position, but also adding to fixed costs through debt. While the Korean company may offer value, it may not have been the best use of cash in light of such uncertainty. The risk that the SASSA contact becomes worthless would leave the company dependent on the Korean business and the scraps of a couple nascent initiatives that have yet to gain traction, such as mobile banking – a field that has plenty of competitors. If the pre-merger business becomes worth very little – $0 for arguments sake – that leaves about $240m of value (the Korean business), while the company currently trades at a market capitalization of $540m. If the company can get the SASSA contract for the entire country, substantial upside exists, but there is ample downside to make purchasing the stock a speculative venture rather than an investment.
Disclosure: None
Talk to Andrew about UEPS
Wednesday, January 12, 2011
George Orwell and the market
Charlie Munger riffs on the value of a liberal arts education all the time. Take looking at urban planning through the lens of math and the interesting results it yields. There are more satisfying conclusions one can reach from borrowing from all academic disciplines than ordering off a Chipotle menu (Over 65,000 combinations). I think a text one would find in an English class that demonstrates a driving force in pricing discrepancies and the misalignment of interests that rear their heads on Wall Street falls under this category. While there are absolutely psychological experiments that demonstrate such concepts, writers can articulate such observations in laymen’s terms in ways that resonate. George Orwell is known for the doublethink of 1984, but a lesser known story of his, Shooting an Elephant, is a demonstration of groupthink or the herd mentality that can grip investors and Wall Street. An unconventional perspective is important in investing and life, because one should not expect all manifestations of the herd mentality to be couched in academic terms or easily identifiable as such.
The story: As a result of his position and identity, an unnamed police officer, also the narrator, is forced to shoot an elephant. The reason for shooting the elephant turns out to be “solely to avoid looking a fool.” The man goes to a town to see an elephant that is allegedly causing destruction. He is the only British person in miles. He clearly states that it is a bad idea to shoot the elephant before he enters the town. Sometimes one’s environment can force them to act in such a way that they did not intend. There are 2,000 locals that gather around the narrator, at which point he is compelled to shoot the elephant.
Such situations are reminiscent of the underlying thought processes that make bubbles a common occurrence and even everyday poor investment decisions. The entire text can be found here and is short (no more than 10 minutes of your time). This is just another way to think about many of the factors involved in investing. Do not make financial decisions in the same manner that the aforementioned narrator does.
Talk to Andrew about liberal arts and investing
The story: As a result of his position and identity, an unnamed police officer, also the narrator, is forced to shoot an elephant. The reason for shooting the elephant turns out to be “solely to avoid looking a fool.” The man goes to a town to see an elephant that is allegedly causing destruction. He is the only British person in miles. He clearly states that it is a bad idea to shoot the elephant before he enters the town. Sometimes one’s environment can force them to act in such a way that they did not intend. There are 2,000 locals that gather around the narrator, at which point he is compelled to shoot the elephant.
Such situations are reminiscent of the underlying thought processes that make bubbles a common occurrence and even everyday poor investment decisions. The entire text can be found here and is short (no more than 10 minutes of your time). This is just another way to think about many of the factors involved in investing. Do not make financial decisions in the same manner that the aforementioned narrator does.
Talk to Andrew about liberal arts and investing
Tuesday, January 11, 2011
The Contrarian case of Contango Oil & Gas on upside in natural gas
Contango Oil & Gas Company (MCF) is a business possessing a lot of characteristics that would attract Warren Buffett. It’s one of the lowest-cost producers in a commodity market with management that has a meaningful ownership stake. The CEO and founder, Ken Peak, started the company in 1999 as a wildcat explorer in the Gulf of Mexico. While the business is pretty straightforward, I don’t possess the edge to gain a leg up when it comes to an oil or gas company for investing purposes. Nevertheless, energy is a huge issue that permeates the investing world so it is worthwhile to be familiar with the environment. The numbers and a lot of the qualitative information on this stock (ROE, margins, low cost provider, great management, aligned with shareholders) give off a positive vibe. For these reasons, I like to pay attention to the company and their recent corporate presentations have presented an upside case for natural gas. It's worth looking at because the bearish case is well known, but the bullish side doesn't get as much attention.
While the stock is not a bargain, his opinions are available for free on the internet as corporate presentations. Yes, the man is talking his own book, which is why one should always be careful of management’s opinion of their business. I have confidence in him to present a thoughtful, albeit potentially biased, outlook on the industry. Let's begin:
Peak is insinuating that the Haynesville field is the key driver of domestic natural gas production over the past 3 years and rig counts are now declining. The three major shale producing fields are showing declines in rigs, which should result in lower production growth in the future. This is a logical progression and his point seems to be that supply is poised to drop. His point about a lot of natural gas rigs really being devoted to liquid natural gas is quite interesting, because it is a more nuanced understanding than an individual such as myself would achieve looking at the sector. The last bullet point about the liquid focus of drilling is further elaborated on in this slide:
This is something I find interesting because it shows how data can be manipulated (broadly applicable too). NGLs can be diverse and some examples are ethane – used in petrochemical feedstocks - and butane – used in a variety of heating elements. While I am no expert, quick Google searches make apparent that gas and natural gas liquids are not fungible. If other investors/media outlets were to not take this extra step of interpretation, then a much differentconclusion would be reached. It could lead to a much more bearish outlook on natural gas prices due to greater perceived supply - ie. solely looking at rig counts or not breaking down gas vs. liquid production growth in shale fields. In reference to the quote at the bottom of the page - I don't know enough about the production profiles of Haynesville versus Eagle Ford, but its possible that year 1 production per rig or people are intentionally focused on wells that will yield more oil and NGLs. Just from the presentation though, it appears that newer shale production coming online isn't going to replace the older fields that seem to be peaking in production. As an interesting side note, this blog recently made a case that NGLs are also being used to inflate the amount of global oil production.
The argument that there is a relationship between coal and natural gas pricing is made in the presentation. While Mr. Peak only uses data for a 2-year period, he points out that coal sets a soft floor under natural gas prices:
I’m not sure this constitutes a bullish insight into natural gas pricing. It is an interesting thing to think about though. The end users of both products tend to correlate to the broader economy (steel, chemicals, electricity, and other industrial uses) and so a correlation between the two should be expected. While the conclusion that coal is setting a floor might be correct, pointing to 2 years of data isn’t exactly a smoking gun. I’m not sure this directly translates into an upbeat case for natural gas since it can be interpreted as a broader recovery in the economy which would then drive natural gas pricing. The spread between the two is way too inconsistent and over too short a period of time to mean much as it is presented.
Another data point from the presentation is the very recent drop in continental US natural gas production. The presentation quotes Pritchard Capital Research on December 29, 2010 that "yesterday the EIA 914 reported that Lower-48 production in October fell by 0.15 Bcf/d...it was in line with out expectations. Louisiana posted its first production drop since December 2009, as the Haynesville Shale has not started to decline due to the shift of capital to oilier areas. Additionally, the EIS also revised downward the 2010 Lower-48 production by 0.5 Bcf/d as it was overestimating the other states 2010 production by almost 3%." This can be the beginning of a downward trend or an outlier, but I can see how one can interpret this as the beginning of a trend. Pointing to the shift of capital to oilier areas is interesting because Chesapeake and other natural gas producers have been shifting to oilier areas, and they are one of the major natural gas producers in the US. On this point, Peak’s assertion is substantiated on this point. Based on what recent news and economics 101 (shifting of resources to more profitable uses), this data point does seem to offer a convincing bullish signal in natural gas. Even a slight downward shift in natural gas production would discredit the conventional wisdom that the US is so awash in natural gas that production growth is going to keep at a rapid rate. It is undeniable that there is huge reserve potential, but it seems to be getting pushed further out as more focus is put on onshore oil drilling. The one thing that I find misleading is saying that December of 2010 saw the first decline in production since December 2009. Maybe I am being overly simplistic in asking "holiday vacation? but judging from the identical month seeing a production slowdown, there is probably a relation.
What is interesting is that this presentation focuses on fields that are have increased production through shale gas drilling. The Appalachian/Marcellus basin is not mentioned despite being a huge natural gas play for both conventional and shale production as shown in this map along with fields in Michigan and Indiana. This table from the IEA does show that most of the shale gas production is in Texas, Louisiana, Arkansas, Oklahoma, and Kansas which is the location of the fields mentioned by Mr. Peak, although it doesn't include 2010 (clearly not enough time for Appalachia to witness explosive natural gas production, so I am not using that as an excuse to assume a whole lot has happened recently that would void his argument). In my opinion, the elephant in the room with this presentation is the lack of discussion of other natural gas prospects, which is the greatest driver behind the low prices as they are perceived to be bountiful and accessible at this time. At the same time, as long as that potential natural gas stays in the ground, natural gas could see a rise in price in the short term. For this reason it might not be necessary for Contango to address this issue.
I found this presentation intriguing because it goes against the conventional wisdom about short-term natural gas prices. Exxon’s purchase of XTO is definitely a long-term bullish signal for the industry, but I don't consider this to be very contrarian other than in timing. It will be interesting to see where natural gas prices go from here, because it can have implications for Global Power Equipment Group, an earlier write-up on this website.
While the stock is not a bargain, his opinions are available for free on the internet as corporate presentations. Yes, the man is talking his own book, which is why one should always be careful of management’s opinion of their business. I have confidence in him to present a thoughtful, albeit potentially biased, outlook on the industry. Let's begin:
Peak is insinuating that the Haynesville field is the key driver of domestic natural gas production over the past 3 years and rig counts are now declining. The three major shale producing fields are showing declines in rigs, which should result in lower production growth in the future. This is a logical progression and his point seems to be that supply is poised to drop. His point about a lot of natural gas rigs really being devoted to liquid natural gas is quite interesting, because it is a more nuanced understanding than an individual such as myself would achieve looking at the sector. The last bullet point about the liquid focus of drilling is further elaborated on in this slide:
This is something I find interesting because it shows how data can be manipulated (broadly applicable too). NGLs can be diverse and some examples are ethane – used in petrochemical feedstocks - and butane – used in a variety of heating elements. While I am no expert, quick Google searches make apparent that gas and natural gas liquids are not fungible. If other investors/media outlets were to not take this extra step of interpretation, then a much differentconclusion would be reached. It could lead to a much more bearish outlook on natural gas prices due to greater perceived supply - ie. solely looking at rig counts or not breaking down gas vs. liquid production growth in shale fields. In reference to the quote at the bottom of the page - I don't know enough about the production profiles of Haynesville versus Eagle Ford, but its possible that year 1 production per rig or people are intentionally focused on wells that will yield more oil and NGLs. Just from the presentation though, it appears that newer shale production coming online isn't going to replace the older fields that seem to be peaking in production. As an interesting side note, this blog recently made a case that NGLs are also being used to inflate the amount of global oil production.The argument that there is a relationship between coal and natural gas pricing is made in the presentation. While Mr. Peak only uses data for a 2-year period, he points out that coal sets a soft floor under natural gas prices:
I’m not sure this constitutes a bullish insight into natural gas pricing. It is an interesting thing to think about though. The end users of both products tend to correlate to the broader economy (steel, chemicals, electricity, and other industrial uses) and so a correlation between the two should be expected. While the conclusion that coal is setting a floor might be correct, pointing to 2 years of data isn’t exactly a smoking gun. I’m not sure this directly translates into an upbeat case for natural gas since it can be interpreted as a broader recovery in the economy which would then drive natural gas pricing. The spread between the two is way too inconsistent and over too short a period of time to mean much as it is presented.Another data point from the presentation is the very recent drop in continental US natural gas production. The presentation quotes Pritchard Capital Research on December 29, 2010 that "yesterday the EIA 914 reported that Lower-48 production in October fell by 0.15 Bcf/d...it was in line with out expectations. Louisiana posted its first production drop since December 2009, as the Haynesville Shale has not started to decline due to the shift of capital to oilier areas. Additionally, the EIS also revised downward the 2010 Lower-48 production by 0.5 Bcf/d as it was overestimating the other states 2010 production by almost 3%." This can be the beginning of a downward trend or an outlier, but I can see how one can interpret this as the beginning of a trend. Pointing to the shift of capital to oilier areas is interesting because Chesapeake and other natural gas producers have been shifting to oilier areas, and they are one of the major natural gas producers in the US. On this point, Peak’s assertion is substantiated on this point. Based on what recent news and economics 101 (shifting of resources to more profitable uses), this data point does seem to offer a convincing bullish signal in natural gas. Even a slight downward shift in natural gas production would discredit the conventional wisdom that the US is so awash in natural gas that production growth is going to keep at a rapid rate. It is undeniable that there is huge reserve potential, but it seems to be getting pushed further out as more focus is put on onshore oil drilling. The one thing that I find misleading is saying that December of 2010 saw the first decline in production since December 2009. Maybe I am being overly simplistic in asking "holiday vacation? but judging from the identical month seeing a production slowdown, there is probably a relation.
What is interesting is that this presentation focuses on fields that are have increased production through shale gas drilling. The Appalachian/Marcellus basin is not mentioned despite being a huge natural gas play for both conventional and shale production as shown in this map along with fields in Michigan and Indiana. This table from the IEA does show that most of the shale gas production is in Texas, Louisiana, Arkansas, Oklahoma, and Kansas which is the location of the fields mentioned by Mr. Peak, although it doesn't include 2010 (clearly not enough time for Appalachia to witness explosive natural gas production, so I am not using that as an excuse to assume a whole lot has happened recently that would void his argument). In my opinion, the elephant in the room with this presentation is the lack of discussion of other natural gas prospects, which is the greatest driver behind the low prices as they are perceived to be bountiful and accessible at this time. At the same time, as long as that potential natural gas stays in the ground, natural gas could see a rise in price in the short term. For this reason it might not be necessary for Contango to address this issue.
I found this presentation intriguing because it goes against the conventional wisdom about short-term natural gas prices. Exxon’s purchase of XTO is definitely a long-term bullish signal for the industry, but I don't consider this to be very contrarian other than in timing. It will be interesting to see where natural gas prices go from here, because it can have implications for Global Power Equipment Group, an earlier write-up on this website.
An explanation of exactly how Warren Buffett values a business
One of the most pressing questions I found myself asking as a Warren Buffett fan, was "how does he do really value these companies?" He mentions how he calculates "owner's earnings" in annual letters, but that is only a starting point for valuing a company. I found this video of Alice Schroeder discussing exactly how Warren Buffett values a business a while ago on ValueWalk and it has remained at the forefront of my mind ever since. Seeing as it only has 16,000 views on YouTube, it hasn't received the visibility it deserves. Alice Schroeder is a great resource because she has spent extensive amounts of time and Warren Buffett trusted her judgment to the point that he let her follow him and write about it. She hasn't recently, but she has a blog/website that offers some Berkshire/Buffett commentary and tea leaf reading. Miguel at Simolean Sense did an interview with Schroeder as well in early November that was very extensive and offered some further insight into Buffett.
What she has to say about his investing methods is quite interesting, because it does not totally confom with how many people perceive it to be. I think the most common perception is that he uses some type of DCF analysis, but in reaction to the video that only seems implicit in his analysis. He does not make any grand assumptions about the future. Even though I find his folksy rhetoric to be somewhat misleading to potential investors, he actually doesn't really need much beyond algebra to calculate value. I'm usually reluctant to say that a video is worth your time, because who wants to spend 48 minutes listening to a lecture after a long day. As she mentions in this video though, Schroeder plans on making a book that focuses exclusively on how Warren Buffett invests/values a company. I wouldn't be shocked to see the book cost more than $35 and take several hours to absorb. While there will be things hashed out in further detail in the book, this is free and takes a fraction of the time to ingest. So I do highly recommend watching this video. Consider it a video/book arbitrage trade.
What she has to say about his investing methods is quite interesting, because it does not totally confom with how many people perceive it to be. I think the most common perception is that he uses some type of DCF analysis, but in reaction to the video that only seems implicit in his analysis. He does not make any grand assumptions about the future. Even though I find his folksy rhetoric to be somewhat misleading to potential investors, he actually doesn't really need much beyond algebra to calculate value. I'm usually reluctant to say that a video is worth your time, because who wants to spend 48 minutes listening to a lecture after a long day. As she mentions in this video though, Schroeder plans on making a book that focuses exclusively on how Warren Buffett invests/values a company. I wouldn't be shocked to see the book cost more than $35 and take several hours to absorb. While there will be things hashed out in further detail in the book, this is free and takes a fraction of the time to ingest. So I do highly recommend watching this video. Consider it a video/book arbitrage trade.
Monday, January 10, 2011
Hey kid, here’s a hundred bucks. CoSine Communications (COSN)
COSN represents an opportunity to earn ~14.5% on $973 in less than a year with minimal downside.
Background: COSN is a relic of the dot-com boom of the 90s that used to be engaged in a money losing business. Now it is just a corporate shell with $2.14 per share in cash held in money market accounts after every residual liability is paid off. The business has ceased operations, it has 0 employees, and its losses are the result of filing expenses and board meetings. Steel Partners (a hedge fund that invests in small cap, in this case nano-cap, companies) is a large shareholder and is responsible for much of the company’s actions. The company has tax loss carry forwards, which can only be used to offset profits (highly unlikely to occur in COSN’s present state with no operations and low interest rates). Steel Partners plans to use the cash on hand in order to acquire a profitable company or make investments that can make use of the tax loss carry forwards.
Opportunity: In their attempt to further consolidate Steel’s control of the company, COSN is planning a reverse 1 for 500 split. For every 500 shares an individual owns, they will receive 1 share. If a shareholder doesn’t own 500 shares, they will be bought out for $2.24/share. This has the effect of knocking out small (very small) shareholders, such as those owning 499 shares or lessIndividuals owning fewer than 500 shares (499 shares @ 1.90 – current price – or $973) will receive $2.24/share ($1117.76). While a $145 isn’t exactly a juicy nominal return, the prospect of receiving an 14.5% return on your money in less than a year is a much better alternative to the meager rates a bank is offering you right now.
While the company is offering $2.24/share, there is only a net cash position of $2.14. The reason this should pose little concern is because Steel Partners owns 47.5% and wants control of the company to exploit the NOLs. Out of 10m shares outstanding, that means just over 5m will be tendered. That requires $11.2m but is more than covered with the $21m on the balance sheet.
Risk: The reason I am comfortable recommending this is due to the limited downside risk. An economist would have you believe that you cannot pick a $20 bill off the ground, because if it were truly on the ground someone else would have picked it up already. In this instance, the amount of unencumbered cash that each share represents would take approximately 2 years to be reduced to the amount of cash that each share can be purchased at even if the tender fails. This risk is nearly eliminated now that the tender has been approved.
Disclosure: no position
Background: COSN is a relic of the dot-com boom of the 90s that used to be engaged in a money losing business. Now it is just a corporate shell with $2.14 per share in cash held in money market accounts after every residual liability is paid off. The business has ceased operations, it has 0 employees, and its losses are the result of filing expenses and board meetings. Steel Partners (a hedge fund that invests in small cap, in this case nano-cap, companies) is a large shareholder and is responsible for much of the company’s actions. The company has tax loss carry forwards, which can only be used to offset profits (highly unlikely to occur in COSN’s present state with no operations and low interest rates). Steel Partners plans to use the cash on hand in order to acquire a profitable company or make investments that can make use of the tax loss carry forwards.
Opportunity: In their attempt to further consolidate Steel’s control of the company, COSN is planning a reverse 1 for 500 split. For every 500 shares an individual owns, they will receive 1 share. If a shareholder doesn’t own 500 shares, they will be bought out for $2.24/share. This has the effect of knocking out small (very small) shareholders, such as those owning 499 shares or lessIndividuals owning fewer than 500 shares (499 shares @ 1.90 – current price – or $973) will receive $2.24/share ($1117.76). While a $145 isn’t exactly a juicy nominal return, the prospect of receiving an 14.5% return on your money in less than a year is a much better alternative to the meager rates a bank is offering you right now.
While the company is offering $2.24/share, there is only a net cash position of $2.14. The reason this should pose little concern is because Steel Partners owns 47.5% and wants control of the company to exploit the NOLs. Out of 10m shares outstanding, that means just over 5m will be tendered. That requires $11.2m but is more than covered with the $21m on the balance sheet.
Risk: The reason I am comfortable recommending this is due to the limited downside risk. An economist would have you believe that you cannot pick a $20 bill off the ground, because if it were truly on the ground someone else would have picked it up already. In this instance, the amount of unencumbered cash that each share represents would take approximately 2 years to be reduced to the amount of cash that each share can be purchased at even if the tender fails. This risk is nearly eliminated now that the tender has been approved.
Disclosure: no position
A Stinky Stock for a Nice Smelling Business? – Parlux Fragrances (PARL)
For those of you that source ideas from a Ben Graham NCAV screen, such as this one, you might be familiar with Parlux. It trades at 67% of its NCAV currently, but it’s possible that recent events have created the opportunity for value greater than just its liquidation. Left for dead, but with low fixed costs and a debt free balance sheet, the founder and former CEO who has returned to the helm. All of the bad news seems to have long been priced into the stock, and even the run up from its lows still shows what low confidence Mr. Market has in Parlux. Let’s examine the story:
Three reasons not to like the stock:
1) Concentrated sales
2) Large account receivables outstanding to a struggling perfume retailer
3) Dependence on one brand for majority of sales
The company derives around 50% of its sales from 2 parties: Macy’s and Perfumania/Quality King. High sales concentration is worrisome because it can leave the company vulnerable to a huge drop in revenue without enough time for the company to cut costs. Further complicating perceptions is that the largest shareholder of Perfumania also holds 10.1% of Parlux stock. This creates potential outcomes that are detrimental to shareholders.
The company’s most recent 10-Q states that the company has $17m in outstanding accounts receivable related to Perfumania (PERF). This was up $7m YoY, most likely related to increased consumer confidence going into the 2010 holiday season. Perfumania is specialty retail company focused on, you guessed, perfume. The company walks a fine line on cash flow, balancing inventory, accounts payable, and a revolving credit facility. Perfumania is highly dependent on strong holiday sales.
Parlux manufactures and markets perfume under brand and celebrity names that is licenses. There used to be twice as much diversity in its main sales generators, with the Paris Hilton and GUESS brands being its top brands. GUESS decided not to renew its license with Parlux, leaving the company dependent on Paris Hilton perfume for 70% of its revenue.
Parlux is a going concern at this point, but one of the key points of this opportunity is that the balance sheet can take some heavy blows. Writing down the accounts receivables owed by Perfumania as well as half the inventory (approximately what one might expect will be sold to Perfumania) can show what the company might look like if Perfumania goes bankrupt. There are A/R of $19.5m and inventory of $20m that would be written down in this instance. That results in a book value of $60m and an adjusted NCAV of $45m, implying a $15m valuation on the business or a $15m premium over the liquidation value (same thing looked at two different ways).
A bright future might await the company due to its relationship with the Garcia Group and Artistic Brands. The Garcia Group owns 16.4% of the stock and hold warrants to another 6,000,000 shares at a $5 strike price. The Garcia Group’s key representative is also a key executive at Artistic Brands. Another executive is Shawn Carter, otherwise known as Jay-Z. AB represents other artists such as Rihanna and Kanye West. It was through this relation that the Rihanna fragrance is about to be launched and the Kanye West fragrance in the future. There is also an agreement for a Jay-Z fragrance as well another unnamed artist that will result in the issuance of an additional 3,000,000 warrants each. The warrants might allow one to interpret an alignment of incentives between the Garcia Group and shareholders in seeing an increased share price.
The dependence on Paris Hilton branded fragrances should decline over the next year as new fragrances launched in 2010 and 2011 gain traction. Although one can only guess, the Rihanna fragrance should prove popular based on the artists popularity. I have very little insight to offer into the psyche of perfume buyers. There is a Kanye West Fragrance slated for fiscal year 2013, which is in time for the 2012 holiday season. This seems quite far off in terms of celebrity trends.
This business is super lumpy because perfume sells in the Mother’s/Father’s Day period and the winter holidays. Annualizing run rate earnings from would not yield a figure that in any way represents the “truth,” provides clarity or offers an insight. The new CEO is the former CEO/founder and he has cut costs. There should be a return to profitability on an annualized basis that will result in a high single digit or low double digit PE, but that is likely where the business should trade since its cash conversion cycle is awful with 6-9 months of inventory and 3 months of accounts receivables. I wouldn’t be surprised to see the stock go up another 30% with positive developments, but similar downside exists at this point too if a Perfumania bankruptcy sucker punches Parlux. This is not an asymmetric bet an investor should take.
The discount to book value at this point isn’t great enough to offer a big enough margin of safety. Several months ago offered a good opportunity to enter the stock and little has fundamentally changed over the run up.
While the CEO has returned, it is doubtful that this represents a Steve Jobs (Apple) or Howard Schultz (Starbucks) moment. The CEO is 73 and has no ownership stake. The true upside in this stock is mostly allocated to The Garcia Group, which could end up owning close to 45% of the company if the company successfully rights the ship. It doesn’t need the company to be a wild success though because a related party to the Garcia Group will receives royalties from the sale of Rihanna and Kanye West fragrances. The alleged alignment of interest with stockholders will prove elusive in my opinion.
One thing to watch would be the traction that new fragrance releases gain. The next earnings release will contain the holiday season. There tend to be discounts in this period but increased volume. The recent news that December retail sales were weaker than expected might be a sign of caution on Perfumania and Parlux as an extension. If Perfumania were to go bankrupt, it would be interesting to see how extreme the valuation of Parlux would get. I would definitely revisit this company if this hypothetical thesis were to become a reality.
Disclosure: None
Three reasons not to like the stock:
1) Concentrated sales
2) Large account receivables outstanding to a struggling perfume retailer
3) Dependence on one brand for majority of sales
The company derives around 50% of its sales from 2 parties: Macy’s and Perfumania/Quality King. High sales concentration is worrisome because it can leave the company vulnerable to a huge drop in revenue without enough time for the company to cut costs. Further complicating perceptions is that the largest shareholder of Perfumania also holds 10.1% of Parlux stock. This creates potential outcomes that are detrimental to shareholders.
The company’s most recent 10-Q states that the company has $17m in outstanding accounts receivable related to Perfumania (PERF). This was up $7m YoY, most likely related to increased consumer confidence going into the 2010 holiday season. Perfumania is specialty retail company focused on, you guessed, perfume. The company walks a fine line on cash flow, balancing inventory, accounts payable, and a revolving credit facility. Perfumania is highly dependent on strong holiday sales.
Parlux manufactures and markets perfume under brand and celebrity names that is licenses. There used to be twice as much diversity in its main sales generators, with the Paris Hilton and GUESS brands being its top brands. GUESS decided not to renew its license with Parlux, leaving the company dependent on Paris Hilton perfume for 70% of its revenue.
Parlux is a going concern at this point, but one of the key points of this opportunity is that the balance sheet can take some heavy blows. Writing down the accounts receivables owed by Perfumania as well as half the inventory (approximately what one might expect will be sold to Perfumania) can show what the company might look like if Perfumania goes bankrupt. There are A/R of $19.5m and inventory of $20m that would be written down in this instance. That results in a book value of $60m and an adjusted NCAV of $45m, implying a $15m valuation on the business or a $15m premium over the liquidation value (same thing looked at two different ways).
A bright future might await the company due to its relationship with the Garcia Group and Artistic Brands. The Garcia Group owns 16.4% of the stock and hold warrants to another 6,000,000 shares at a $5 strike price. The Garcia Group’s key representative is also a key executive at Artistic Brands. Another executive is Shawn Carter, otherwise known as Jay-Z. AB represents other artists such as Rihanna and Kanye West. It was through this relation that the Rihanna fragrance is about to be launched and the Kanye West fragrance in the future. There is also an agreement for a Jay-Z fragrance as well another unnamed artist that will result in the issuance of an additional 3,000,000 warrants each. The warrants might allow one to interpret an alignment of incentives between the Garcia Group and shareholders in seeing an increased share price.
The dependence on Paris Hilton branded fragrances should decline over the next year as new fragrances launched in 2010 and 2011 gain traction. Although one can only guess, the Rihanna fragrance should prove popular based on the artists popularity. I have very little insight to offer into the psyche of perfume buyers. There is a Kanye West Fragrance slated for fiscal year 2013, which is in time for the 2012 holiday season. This seems quite far off in terms of celebrity trends.
This business is super lumpy because perfume sells in the Mother’s/Father’s Day period and the winter holidays. Annualizing run rate earnings from would not yield a figure that in any way represents the “truth,” provides clarity or offers an insight. The new CEO is the former CEO/founder and he has cut costs. There should be a return to profitability on an annualized basis that will result in a high single digit or low double digit PE, but that is likely where the business should trade since its cash conversion cycle is awful with 6-9 months of inventory and 3 months of accounts receivables. I wouldn’t be surprised to see the stock go up another 30% with positive developments, but similar downside exists at this point too if a Perfumania bankruptcy sucker punches Parlux. This is not an asymmetric bet an investor should take.
The discount to book value at this point isn’t great enough to offer a big enough margin of safety. Several months ago offered a good opportunity to enter the stock and little has fundamentally changed over the run up.
While the CEO has returned, it is doubtful that this represents a Steve Jobs (Apple) or Howard Schultz (Starbucks) moment. The CEO is 73 and has no ownership stake. The true upside in this stock is mostly allocated to The Garcia Group, which could end up owning close to 45% of the company if the company successfully rights the ship. It doesn’t need the company to be a wild success though because a related party to the Garcia Group will receives royalties from the sale of Rihanna and Kanye West fragrances. The alleged alignment of interest with stockholders will prove elusive in my opinion.
One thing to watch would be the traction that new fragrance releases gain. The next earnings release will contain the holiday season. There tend to be discounts in this period but increased volume. The recent news that December retail sales were weaker than expected might be a sign of caution on Perfumania and Parlux as an extension. If Perfumania were to go bankrupt, it would be interesting to see how extreme the valuation of Parlux would get. I would definitely revisit this company if this hypothetical thesis were to become a reality.
Disclosure: None
Friday, January 7, 2011
A good list of stocks to research
Now that Oozing Alpha is going behind a pay wall, a great source of info on post reorg equities, spin offs, and special situations is going off my list of resources. Thankfully, Hunter at Distressed Debt Investing just posted this list which contains the names of companies that defaulted in 2010. There are a couple names that stick out such as RHI Entertainment, a name that Seth Klarman had a position in prior to the bankruptcy. Neenah Foundry is a familiar name that I would constantly see on man hole lids in the Chicago area, and for some reason the name has stuck with me. As Hunter mentions, some of these companies already have listed shares. I hope to look at these in the near future for ideas. And while I'm on the subject of investing resources, I would like to highlight this screen, a Ben Graham NCAV screener. This is a great screen and highlights one of the statistically successful strategies an investor can employ as Tweedy Browne's What Has Worked In Investing paper discusses, among other strategies. This screen is something I notice coincides with a lot of stocks highlighted on Barel Karsan, although they are by no means identical. The screen is usually composed of pretty distressed companies, but at the point where the price is closer to its liquidation value than its value as a going concern. Cherry picking companies that are still healthy can be a profitable strategy. I will be giving an in depth look at a company that is on this screen over the weekend.
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