Special Situation Investing

Etrade Canada Venting

2007-04-21T09:05:00.000-07:00

Well just looked at my latest transaction from Etrade Canada and man am I pissed. I usually trade in American dollars so I haven't really noticed this before but the company is charging very excessive rates on my trades. I bought stocks yesterday when the exchange ratio was in the 1.12-1.125 CAD per USD range. Great. Etrade, however, actually ended up using an exchange ratio of closer to 1.143 on my purchase. That amounts to a ~2% grab just on the exchange ratio! That is huge! Consider that you will also pay ~2% on the way out as well. It makes it completely impossible to own stocks for anything less than years. A cigar butt with a 30% gain isnt' even worth your time as after Etrade takes it's bite you only have 26%.

I think these fees are excessive, swept under the mats and frankly I'm looking for a new online broker. IF anyone knows of one that doesn't charge massive exchange rates, let me know.

State Street Financial (SSFC) - Going Private Transaction

2007-03-24T11:42:00.000-07:00

Well it's now official. After a shareholder vote, SSFC will be repurchasing from shareholders with fewer than 750 shares for $10 a pop. The stock closed around $8.60. I obviously didn't get rich off of this one but it was low risk and a high rate of return relative to the time I was invested.

More details on SSFC here.

Temple-Inland (TIN) - Split-up Announced

2007-03-24T11:35:00.000-07:00

After prompting by Carl Icahn, Temple-Inland (TIN) has announced that they will be splitting up by year's end.

The forest-products company said Feb. 26 that it plans to split into three public companies and sell its timberlands by year-end.

...

But Jastrow is willing now to spin-off his company's financial services and real estate operations while keeping its manufacturing operations, which include packaging and building products. "Each of the three public companies - manufacturing, financial services and real estate - will be well positioned in the marketplace, have an appropriate capital structure and will benefit from greater strategic focus," Jastrow said in the release.

Buffet - Words of Wisdom

2007-02-27T20:52:00.000-08:00

Thought this quote was rather appropriate on a day like today.

"Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."

Warren Buffet

Let's get back to the market. Nothing has fundamentally changed in my view. So Chinese banks can't loan out quite as much money. This was announced in advance, I remember reading it. I mean let's think about what is happening here. The Chinese government is taking steps to temper growth and prevent recession. What is wrong with that? Would the market have preferred if they let the train run off the tracks? When I read about the major recessions in Japan and in the US it seems one of the biggest problems was the government stood idly by. China may or may not hit a recession but long-term I view the current situation as a positive. The biggest risks when investing in China are political not economic in my view.

Somebody had a run at Cheney? How is that different from any other day? Don't get me wrong, I feel the situation is horrible and I really do have sympathy for those who lost their lives in the attacks. However, I also have sympathy for those who have lost their lives in all the prior suicide bombings that the market completely ignored. I don't see what the difference between today and any other day was.

Greenspan thinks there might be a US recession. He says the bull market is long in the tooth. Jesus christ, is this not something people could have figured out for themselves? Is he doing anything other than validating what anyone who went through the last bubble/crash is already thinking?

I don't know what is going to happen tomorrow or even this year but staring at these long rows of red I can't help thinking that maybe, finally prices are going to get back to levels where I can really start buying again.

Travelcenters of America (TA) - Spunoff from Hospitality Properties Trust (HPT)

2007-02-25T17:02:00.000-08:00

Found an excellent post detailing the spinoff of Travelcenters of America (TA) from Hospitality Properties Trust (HPT). Unfortunately, I am already over a month late on this one and it has seen a tremendous surge from $28-29 to over $38 on Friday. Still worth watching, analyzing and potentially buying. I don't have time right now but I'll get back to this one. For now, check out the post link above.

Update

A reader posted a comment to this entry and I thought it deserved inclusion.

An excellent post?? It's an awful post. It doesn't detail the huge lease commitments to HPT (+$150MM/pa and rising)and fools you into thinking there's "no debt". It doesn't detail the onerous restrictions HPT placed on TA (like that HPT has to finance every deal and has right of first refusal everywhere), doesn't discuss all the insider conflicts, doesnt say what happens when the lease expires. And the low multiples referred to are not substantiated. There's no company guidance and limited historical info. Read the S1, it's impossible to conclude what normalized cash flow is without making stupid assupmtions, like basing multi year forecasts on one nine month period. Stock is up from all the folks who read the blog and bought the stock without doing homework. I'm not short TA and am not even saying that it's necessarily a bad idea but I am saying that there's a lot more to the story including a lot of negative stuff and that it is not as cheap as Harper makes it out to be. Read Feb20 Wall Street Journal article "TravelCenters Aims to Please--Its Ex Owners" and of course read the S1--
http://www.financials.com/custom/cbig/filing.cfm?filingid=1382&csymbol=TA

This reader does have a point. I try to post references to all spinoffs I come across, good or bad, and if you've read my blog you'll know that I think most are bad. After having a chance to review (briefly) the situation I would have to agree that the initial writeup didn't cover all of the issues. Reviewing the S1, there are a number of issues, highlighted by the reader above, that do need to be addressed. Honestly, I just don't have time right now to really crunch all the numbers out but I have extracted some of the more relevant data from the S1. I highly recommend you go through the S1 yourself to reach a decisive conclusion.

From the S1.

We were formed for the benefit of Hospitality Trust and not for our own benefit. Our formation allows Hospitality Trust to acquire and retain ownership of 146 travel centers without adverse tax consequences to Hospitlity Trust. Because we were formed to benefit Hospitality Trust, some of our contractual relationships and the terms of our initial business operations may provide more benefits to Hospitality Trust than to us.

...

Our creation was, and our continuing business will be, subject to conflicts of interest, as follows:

•: Two of our directors were trustees of Hospitality Trust at the time we were created.
•: Upon completion of the spin off we will have five directors, one of whom, Mr. Barry Portnoy, also will be a trustee of Hospitality Trust and the majority owner of Reit Management, one of whom, Mr. Arthur G. Koumantzelis, is a former trustee of Hospitality Trust, and one of whom, Mr. Thomas O'Brien, is a former executive officer of Hospitality Trust.
•: Mr. O'Brien who will be active in our senior management activities is also an employee of Reit Management. Another Reit Management employee, John R. Hoadley, is our treasurer and will also be active in our senior management activities. Reit Management is the manager for Hospitality Trust and we will purchase various services from Reit Management pursuant to a management and shared services agreement.

These conflicts may have caused, and in the future may cause, adverse effects on our business, including:

•: Our lease with Hospitality Trust may be on terms less favorable to us than leases we could have entered as a result of arm's length negotiations.
•: The terms of our management and shared services agreement with Reit Management may be less favorable to us than we could have achieved on an arm's length basis; specifically, our payments to Reit Management of 0.6% of our fuel gross margin and 0.6% of our total non-fuel revenues for shared services, equal to $4.7 million on a pro forma basis for the nine months ended September 30, 2006, may be greater than if these services were purchased from third parties.
•: Future business dealings between us and Hospitality Trust, Reit Management and their affiliates may be on terms less favorable to us than we could achieve on an arm's length basis.
•: We may have to compete with Hospitality Trust, Reit Management and their affiliates for the time and attention of Messrs. Portnoy, O'Brien and Hoadley

...

Minimum Rent. The lease requires us to pay minimum rent to Hospitality Trust as follows:

Lease Year	Annual Rent (000s)		Per Month (000s)
1	$	153,500	$	12,792
2		157,000		13,083
3		161,000		13,417
4		165,000		13,750
5		170,000		14,167
Thereafter		175,000		14,583

In addition, minimum rents may increase if Hospitality Trust funds or reimburses the cost of renovations, improvements and equipment related to the leased travel centers as described below.

Improvements. Hospitality Trust has agreed to provide up to $25 million of funding annually for the first five years of the lease for certain specified improvements to the leased properties. This funding is cumulative, meaning if some portion of the $25 million is not spent in one year it may be drawn by us from Hospitality Trust in subsequent years; provided, however, the entire $125 million of funding must be drawn before December 31, 2015. All improvements will be owned by Hospitality Trust. There will be no adjustment in our minimum rent as these amounts are funded by Hospitality Trust.

...

Income from operations. Our predecessor generated income from operations of $74.3 million for the nine month period ended September 30, 2006, compared to income from operations of $77.2 million for the same period in 2005. This decrease of $2.9 million, or 3.8%, as compared to the 2005 period was primarily the result of the $11.9 million increase in share based compensation expense in the 2006 period. The effect of increased share based compensation expense was somewhat offset by the $4.4 million expense reduction related to claims settlements and the increased gross profit that resulted from increased fuel and non-fuel sales volumes and fuel margins per gallon.

Goldman Sachs (GS) - Portfolio Insurance Puts

2007-02-20T10:24:00.000-08:00

I can't help feeling increasingly nervous as the major indexes continue their ascent. While we are certainly not seeing the degree of optimism in the 99/00 bubble it does seem that the markets are warming up to the idea of prosperity. I however, have my doubts. Now I don't want to be one of those fire and brimstone perma-bulls who is constantly predicting the end. However, I feel there is a realistic and poorly discounted chance that the economy will hit a snag or worse.

It could be housing, consumer debt, depreciation of the dollar, or some unforseen series of events. I really just don't know. However, I am not willing to continue to hold the overwhelming bulk of my net worth long in equities.

As such, I have decided to purchase some puts to offset the risk. I don't normally condone hedging as I feel it generally just diminishes results. However, the risk premium on certain companies is sufficiently low that it seems like a good bet. Today, for instance, I bought $180 Jan/08 puts on Goldman Sachs (GS) for $5.50 an option. For those new to options, what this means is that for $5.50 a share I have the right to sell GS for $180 up until the third friday of January 2008. Of course, this only makes sense if GS dips below $180 over the next year, otherwise the position is a complete loss.

Let me give you an example. If the stock price were to descend to say $150, well you could buy the shares for $150 and sell them for $180, providing a $30 spread. Given that you bought the options for $5.50 and generated $30 from the trade, this scenario would provide a 445% profit. It is more complicted than this as the options are worth more than the spread based on the amount of time remaining before expiration. Also, you don't actually need to do the buying and selling of the shares, you can just sell the options and let someone else worry about it.

Back to Goldman. If you don't know, Goldman Sachs is probably the preeminent investment bank of the world. As the number of IPO's and leveraged buy outs have surged, GS has benefitted. They also operate significant internal trading operations which have generated substantial profits lately. Over the last few years I have watched their stock price explode from the $80-90 range in 2004 to over $220 at the time I sit writing this.

Now I am not saying that GS is not a good company. I actually think it is an excellent firm with a strong reputation and I would never short the stock. However, it is highly leveraged to the success and failure of the stock market. Should things turn south, Goldman will feel the pain and in amounts proportionately higher than the rest of the market. There is also, always the small chance of failure of some magnitude by it's investment division even in an up market. Look at the demise of Amaranth for example. I have heard many good things about GS's investments, how they always seem one step ahead of the market and the massive amounts of profit they generate. I am skeptical. People make mistakes, computer models have flaws and limitations, six-sigma events DO happen in the market.

I should mention that the options I have purchased represent a VERY small proportion of my portfolio. Roughly 0.5% of my net stock holdings. So I can afford to take a complete loss on the thing and it would just be a marginal tick off my gains for the year. However, in a nasty market, one where the stock market gets hit 20-30% I can envision turning a profit of 5-15x my investment, thereby buffering my other losses.

Halliburton (HAL) - Spinoff of KBR Unit Continued

2007-02-18T21:43:00.000-08:00

I did a bit more digging on the specifics of the KBR spinoff from HAL. The initial IPO of KBR stock represent approx 19% of outstanding stock. The remaining portion will be distributed by Halliburton to existing shareholders, hopefully via a spinoff. KBR currently has a market cap of $3.74 B which includes the 81% ownership by HAL. As such, ~$3 B of HAL's market cap is attributable to it's KBR stock. Excluding that $3 B from HAL's market cap of $30 B gives a rough value of $27 B for HAL post-KBR.

So you could say that the market is valuing HAL's energy services group at $27 B. Energy services provided $3.4 B operating income in 2006 and $2.3 B in 2005. This was generated from $13B revenue in 2006 vs $10B in 2005. Interest expense was nominal and largely counterbalanced by interest income. Taxes take roughly 1/3 of profits. This leaves us with $2.3 B or so net income from the energy group against the $27B market cap and provides for a P/E of less than 12. The unit is likely to grow at least in the short-term as demand for it's services continues. The oil majors, especially Exxon (XOM), have been holding back on oil exploration until the last couple years after being burnt by previous oil rallies. This is starting to change, as confidence that oil will remain high historically builds and as the majors struggle to maintain existing production. The company also has decent geographic diversity with ~55% of revenue coming from outside North America.

What you need to keep in mind, however, is that in the long-run if the price of oil were to fall the majors eventually would scale back their exploration and development projects. Have a look at it's five year chart to see how much it has surged with the price of oil.

Theoretically, KBR should be the asset of choice in this transaction. It is significantly smaller than HAL ($3.7 B against $27 B), it is hated, it's dependance on government contracts make revenue and earnings unpredictable, and it is in a different sector than HAL. By all rights, this stock should get pounded after the spinoff occurs. You would think that most HAL owners would just love to get rid of the stock and associated bad memories. We will see if that happens. Personally, I would only be a buyer of KBR if it got absolutely nailed as at present I am not particularly interested in this type of business, I don't see much competitive advantage and god only know what it's future revenue will be like. In other words, it legitimately might be a bad buy and needs a greater discount for me to purchase. Consider that it IPO'd at $17 and currently trades for $22.88 so it is already considerably higher than initially valued by it's owners.

HAL is not the only cheap oil services company either, Baker Hughes (BHI) goes for about 13x forward estimates and Schlumberger (SLB) for about 13.5 x forward earnings. So yes it is cheaper than it's competitors but then again it has lower margins than them as well.

On the flip side, I'll just throw in that George Soros bought some 1.9 million shares in HAL during the past quarter.

What it comes down to is your perception of where oil prices are headed. They don't need to surge upwards for HAL to be a good buy, even if the market could maintain present prices for awhile you could see upward pressure on the stock. However, I already have energy exposure and quite frankly I think Schlumberger is a superior company to HAL. I will keep an eye on the price of KBR and may take advantage of any selloff's that occur post spinoff.

If you are still interested in HAL, check out the fourth quarter results here.

Halliburton (HAL) - Spinoff of KBR Unit

2007-02-17T20:35:00.000-08:00

While not exactly recent news, I thought it was worth mentioning that Halliburton (HAL) is planning to spinoff it's engineering and goverment services division, KBR, this April. KBR stock was initially floated in November with the bulk of the shares to be distributed via the April spinoff. The KBR unit has been plagued by negative publicity and investigations into the allocations of government contracts. The division's reliance on the distribution of government contracts, which can produce very lumpy results, also limits the earnings multiple. No doubt, HAL is hoping that a spinoff will allow it's oil services section to receive a higher valuation level with little impact on the value of KBR.

At first glance this appears to be a compelling spinoff situation. Halliburton plays a prominent role in a booming albeit highly cyclical industry. One of the limiting factors in oil exploration and development, in fact, is the rising cost of the enabling technologies provided by Halliburton amongst others.

I plan to do more analysis on the specifics over the next few days with a more detailed post to follow. In the meanwhile, if anybody has any comments on the spinoff I would appreciate hearing them.

Time Warner Cable (TWC) - Cleared for Trading

2007-02-13T10:09:00.000-08:00

Time Warner Cable has cleared regulatory hurdles and should begin trading as a separate company (TWC) on March 1. As the name suggests, TWC is majority owned by Time Warner (TWX) and represents assets purchased from bankrupt Adelphia.

Even after becoming public, the company will still be majority owned and controlled by its parent company Time Warner Inc
..
Time Warner Cable will distribute 156 million shares of its stock, or about 16 percent of its total outstanding shares, to stakeholders in Adelphia. That stake is valued at approximately $6 billion
..
Time Warner Cable's shares have been trading on a temporary or "when-issued" basis on the New York Stock Exchange since early this year under the symbol "TWCAV." Those shares slipped 25 cents to $40.75 in midday trading.

Webzen (WZEN) - Distribution Agreement

2007-02-12T16:34:00.000-08:00

Korean online game developer Webzen (WZEN) has signed an agreement with The9 to distribute it's new release Huxley, in China. WZEN surged over 9% on the news.

The total projected amount of the agreement for Huxley’s distribution and service rights is estimated at $35 million. This includes the down payment and a minimum guarantee for a three-year period, while the royalty rate is set at 22% for the duration of the contracted term. The agreement covers the PC version of the game.

To put things into scope, China is only 1 of many markets and the company has several other products in-use and under development. As such I don't know that this is as significant an event as the price change would indicate. Then again, I've believed in Webzen for awhile, having previously purchased shares. What I am hoping, what I have seen in the past, is that the company will continue to get it's new games out and press releases like this will continue to print. However, having seen it 20% lower I see no reason to add to my position and will just hold my existing shares.

Asset Acceptance Capital Corp (AACC)

2007-02-12T16:11:00.000-08:00

A reader of this blog wrote in with a fairly detailed description of a company he is tracking. While it isn't really a special situation there is no point in letting his analysis go to waste.

I'm not sure if it qualifies as a special situation though, Asset Acceptance Capital Corp (AACC). It buys unpaid consumer debt, mostly credit cards, and collects on them using call centers and legal filings. It has a number of publicly traded competitors (PRAA, ASFI, FCFC, ECPG). People generally seem to think that PRAA is the class of the industry, but it trades at a higher valuation. AACC has a 52 week range of 14-21.4 and is currently trading at 15.73.

The sector in general has been battered because the price paid for debt has been going up as more players have gotten involved in the industry. AACC in the latest quarter said their cost to acquire debt has gone to 3.54 from 2.49 cents on the dollar in the previous year. AACC earned 10.7 million or .29 cents a share as opposed to 13.7 million (37 cents a share) the year before. Cash collections increased 3.5% from the previous quarter, but revenues decreased due to lower expected returns on their portfolio and a 6.3 million dollar impairment charge.

AACC like most of the industry uses the IRR method of accounting where they assign an estimated internal rate of return to each purchased collections portfolio and any amount collected above the IRR is applied towards the principal of the portfolios. If revised cash flow estimates don't meet the IRR an impairment is taken, but the IRR remains unchanged. This adds lumpiness to earnings as portfolios are marked down instead of just earning a lower rate of return over time (for accounting purposes).

Asset Acceptance have 320 million in tangible assets and 76 million in tangible liabilities (58 million of which is a deferred tax liability) with no debt. This gives them a tangible book of 244 million or 2.4 times their market cap of 588 million. They have earned roughly 0.30 the last three quarters and would have earned $0.40 cents in the 4th quarter of 2005 if it wasn't for a very large write down they took on a newly acquired portfolio of wireless bills (an asset class they had just ventured into). Their earnings have been declining in 2006, and their returns on capital have been declining for a long time due to increased competition.

I think the real question about this industry is should they be trading at a premium to their tangible book value and if so how much? The answer to the first question is clearly yes, because it takes knowledge, organization and experience to collect a portfolio of receivables. AACC has a table in their 10-K that shows account executives who have a year or more experience are 50% more effective than their less experienced co-workers. The second question is much trickier. The lack of debt on AACC's books give it some leeway when in comes to maintaining earnings in the face of declining returns on assets. They could borrow money, buy back stock and maintain their current level of earnings if industry ROA's where to decline somewhat. Also, at some point the industry becomes unattractive for new competitors to enter it.

At this point my thinking on the situation becomes more nebulous. On the one I don't think there are particularly steep barriers to entry to get into the industry. On the other hand I don't think it's an industry that the best and brightest of America's business schools are clamoring to get into. I don't think there is a lot of glory of it. I think this probably keeps the level of competition down and smart talented people in the industry can do reasonably well. This brings me to the question of why AACC as opposed to the other companies in the industry. The answer to this is that I found their financials to be well organized and straight forward with lots of useful information that an owner (stockholder) of the business might want to know. Their competitors financials I found less well organized and presented (I didn't look closely at PRAA because of its status of industry darling). One of their competitors had much higher ROE's but buried in its financials was the disclosure that it sold most of the receivables for big gains without actually collecting them (this strategy won't work if receivable prices don't keep increasing).

MY REVISED THINKING:

Most of AACC reported earnings come from receivable portfolios that were acquired at much lower prices 1-2 years ago. In their latest quarter they reported that they invested 27 million in new receivables the same as last year. However they only expect to have 53 million in revenue from this portfolio as opposed to 70 million from the one purchased in 2005. A significant decline in revenue with collection expenses staying constant/rising is going to cause a dramatic drop in earnings. Yes they can use leverage to make up for some of this, but I don't think their going to be able to borrow at rates that are all that great. I think I will look at this company again 1-2 years from now. It might be interesting then. At some point they will be reporting really ugly earnings, but probably have a lot of earnings power going forward due to a drop in the purchase price of unpaid debt. Then will be the time to strike. I'm glad I composed this e-mail so I can get out. Hmm..it might be a short opportunity.

...

You should probably note though that on Monday I am selling my long position in AACC and possibly getting short.

Bayard

I will keep watching this one. I have to agree that it's lack of coverage may be keeping it's pricing down. That in addition to it's un-glamorous industry are characteristics that tend to make for good investments.

Thanks for the post Bayard!

Western Union (WU) - Article Link

2007-02-11T08:30:00.000-08:00

Motley Fool has a good and most importantly, free, article on Western Union. The article attempts to analyze the company from a value perspective but along the way makes some good points on growth :

Management noted it still only has 17.4% of the $269 billion global cross-border remittance (sending money internationally) market, and it captured about 7.4 points of that in the past three years -- indicating that a lot of share is still up for grabs.

...

International business has grown 26% annually since 2001, and China grew over 30% in 2006.

I bought some shares in Western Union a couple of weeks ago.

Spinoff Tracker Index - Rebuttal

2007-02-09T15:45:00.000-08:00

One of my main priorities in investing is to always stay level-headed and unbiased. As such, I wanted to pass on an email I received in regards to my previous post on a spinoff tracker index. The author makes a number of good points so I will allow you to decide for yourself the merits of the index.

Matt,

I felt I should write you after reading your post on our index.

We have licensed the index to Claymore who has issued the ETF symbol:
(CSD).

Our methodology is more quantitative than qualitative and followed some of the knowledge gained from research performed before we created the first investable spin-off index.

Specifically:

Academic

Penn State University: Cusatis et al., 1993

Purdue University: McConnell et al., 2004

Wall Street/Consultant research

McKinsey: Anslinger et al., 1999

Goldman Sachs: Stelmach et al., 2006

Lehman Brothers: Dickson et al., 2006

Our back-tests did not data mine and took into account certain survivor biases. We feel our work was sound and I personally invested in the Claymore/Clear Spin-Off ETF on its opening day.

Please feel free to contact me if you would like more details. Our site is reasonably complete and I am blogging on many of the constituents.

Best regards,
Andrew Corn
CEO
Clear Indexes LLC
Blog: www.ClearAMIdeas.com

Weyerhauser (WY) - Initiates Domtar spinoff/stock exchange

2007-02-09T10:02:00.000-08:00

Weyerhauser (WY) has initiated it's Domtar stock exchange program, which implements the spinoff of their fine paper division:

Under the terms of the offer, participating Weyerhaeuser shareholders will receive approximately $1.11 worth of Domtar Corporation common stock for each $1 of Weyerhaeuser shares tendered in the exchange offer, subject to a limit of 11.1442 shares of Domtar Corporation common stock per Weyerhaeuser share. The value of Weyerhaeuser shares and Domtar Corporation common stock will be calculated using the simple arithmetic averages of the daily volume-weighted average prices (VWAP) of Weyerhaeuser common shares and common shares of Domtar Inc., respectively, on the New York Stock Exchange on the last three trading days of the offer, unless the offer is subject to the mandatory extension described below.

Keep in mind that if the offer is over-subscribed, you are not guaranteed to fully exchange your Weyerhaeuser shares for Domtar.

Weyerhauser also announced earnings today.

Weyerhaeuser Company (NYSE: WY - News) today reported net earnings of $395 million for 2006, or $1.61 per diluted share, on net sales of $21.9 billion. This compares with net earnings of $733 million, or $2.98 per diluted share, on net sales of $22 billion for 2005.

Excluding one-time items, earnings were only .68.

It is also worth noting that the company repurchased 5.5 million shares of stock during the past quarter. WY has ~240 million shares outstanding.

I originally posted about the WY spinoff of it's fine paper division here.

Update

Did just a bit more digging and I have figured out a few more pieces of the WY spinoff puzzle.

If you are interested in the nitty-gritty of the transaction, click here, if you accept their agreement, in the following screen click on the prospectus link.

At present WY expects 281 million shares of Domtar will be available for exchange. As previously mentioned the company is offering to convert WY shares to DTC at a maximum rate of ~$1.11 worth of DTC for each $1 of WY. For the price to use in setting the exchange rates, they are using the values of DTC & WY averaged over a 3 day period at the end of February - beginning of March. WY estimates the maximum number of shares of WY they would accept for the ~281 million DTC shares is ~25 million. WY has ~240 million shares outstanding. So at most 10.5% or so of their outstanding shares could be converted to Domtar.

To add another twist, their is a possible delay added to the deal. If it over-subscribed, that is if there are more shares offered than are available for trade, there will be a 2-day delay added. During this period those shareholders who offered their shares may either transfer at the adjusted exchange rate or not transfer at all.

Unless you hold an amount less than 100 shares, WY will apply prorationing to the subscription. What this means, I believe, is that even if you submitted 100 shares you may only be allowed to convert a portion of them to Domtar shares. For instance, the company may only accept 50% of those shares if the offer is 100% over-subscribed, or 25% of the shares if the offer is 300% oversubscribed. The remaining fraction of the shares are returned to the shareholders. However, if you own less than 100 shares you can request not to be subjected to prorationing. It appears that this is a case where small investors may have an advantage. You can submit up to 99 shares and then, based on the closing prices, be relatively confident of making a gain, over the averaged prices in those 3 crucial days. Of course, if the stocks were to move significantly before the calculation or after, if the spread between WY and Domtar was to exceed the maximum 11.1442 maximum ratio of shares exchangable, the gains coud be reduced or even turn into losses but it still sounds appealing.

I am going to keep digging into this one.

Incremental Update

2007-02-08T17:56:00.000-08:00

United Parcel Service (UPS) announced plans to increase it's quarterly dividend by 4 cents (~10%) to .42, and upped it's buyback limit to $2 billion. For reference, the company currently has a market cap of ~$78 Billion, and a share price at $73.33. I purchased shares in UPS about a week ago.

Philip Morris, majority owned by Altria (MO) increased the price of certain cartons of cigarrettes by $1.99 today. Also today, competitor Reynolds American (RAI) saw a slip in earnings as excessive shipments in the previous quarter and higher promotional expenses cut into profits. After the slip, Reynolds trades at 15.3 times past earnings. This is very comparable to MO's current valuation, post-Kraft. Excellent article over here, with the goods on Altria's future prospects.

A Few Things

2007-02-07T16:16:00.000-08:00

Tyco dropped .62 today, to $31.97. Even though I own shares, I can't help enjoying this as I would really like to put some more money into the thing. Really, the more I think about it the more I like it. Let's just see the price get down a little further.

Decent article over here about a turn-around in progress at RadioShack. My problem with this one is that the company's revenue to market cap is already pretty high at .7 or so. Walmart, in comparison, has a rev/market cap of .65. So it's priced high and we're still in the opening innings of the turn-around. Not going to bite at this one.

Good top-10 list here of some value stocks. The thing I like about this one is that there is an explanation of why each stock is a buy.

Tyco (TYC) Spinoff

2007-02-06T16:02:00.000-08:00

I have posted about it before, but just a note that Tyco released it's results a few days ago, and announced that the breakup of the company should be happening in April. Tyco is a conglomerate and fallen angel, both of which make for a good spinoff. By splitting apart related businesses, ideally the businesses should prosper under intensified management scrutiny. Also, by splitting up, perhaps some of the bad-will left over from the previous CEO's corruption can finally be put to rest.

The company will be split into 3 new companies: 1) health care, 2) electronics and 3) engineered and safety products. Breen, the current CEO, will take over the engineering/safety business. This in itself is admirable as his division has the worst growth prospects. Based on interviews I have seen of him, I have a lot of respect for the man as he really seems focused on enhancing shareholder value. By splitting up he is robbing himself of power but for the benefit, hopefully, of shareholders.

I am not going to go out and recommend this stock or do a real analysis on it due to lack of time. I will tell you that a number of value investors including Chris Davis and Warren Buffet (albeit a relatively small percentage of his portfolio) hold the stock. I have also seen many arguments for why the sum of the parts will equal the higher $30's or low $40's (stock currently trades at $32.50) and they seem plausible. A decent article on the breakup can be found here.

From the article:

Bates sees the health unit eventually trading for $15 to $17 a share, or 17 to 19 times the earnings he projects.
..
Bates figures the electronics business is worth $12 to $14 a share, on a P/E of 16.5 to 19.
..
In all, the unit containing fire, security and other businesses should trade for $11 to $14 a share, Bates says, with a P/E of 15 to 17.

I own a position in Tyco from before the spinoff was even announced and before I started this blog but I never bothered to put it on my stock list. Personally, despite what the value guys are saying, I would be hesitant to throw new money at it. I just can't get over that it was selling for $25 this summer.

Spinoff Tracker Index

2007-02-05T07:49:00.000-08:00

Clear indexes has built an index of a variety of spinoff companies, here. I am not sure that you can actually invest in the index but for those looking for a list of spinoffs this would be a good starting point. Unfortunately, the spinoffs don't show up on the list until after they are spun out and even then, the index is only updated semi-annually.

A description of the indexes methodology is as follows:

Potential Index constituents include all equities trading on major U.S. exchanges of companies that have been spun-off within the past two years.
The Spin-Off Index comprises the 40 highest-ranking stocks chosen from the universe of spun-off companies.
Each company is ranked using a 100% quantitative rules-based methodology that includes composite scoring of several growth-oriented, multi-factor filters, and is sorted from highest to lowest.
The 40 highest-ranking stocks are chosen and given a modified market cap weighting with a maximum weight of 5%.
The constituent selection process and portfolio rebalance is repeated semi-annually.

I have a couple of problems with the index beyond it's use as a reference. In general, I have a hard time believing that any semi-automated system can do well over time. Also, having an analytical background, I am very skeptical of past performance studies, in this indexes case the performance is tracked back 5 years. Anything less than 20 or 30 years is meaningless in my opinion, and even then, who's to say the next 20 to 30 years will be the same as the past. If you do insist on automatic selection then you better have a broad sweep of companies (500+) to provide for diversity. Also, with the vast growth in hedge funds any well-documented and successful strategy, e.g. picking spunoff companies, tends to get exploited and the gains reduced. Not to say that spinoffs aren't attractive, in some cases they certainly are, just that they are not what they once were. That is why I don't actually buy the majority of spinoffs I see, I still try to apply qualitative and quantitative analysis, and pick the most promising ones.

Anyways, that's just my opinionated ramblings and maybe it's just my ego talking. Like I said, the list is certainly worth monitoring if you're interested in special situations.

Nikko Cordial (NIKOY.PK) - Possible Delisting

2007-02-03T07:34:00.000-08:00

Controlled Greed has some coverage of a possible delisting in a Japanese ADR, Nikko Cordial. I highly recommend you read the comments as that is where the real goodies are.

Verizon Communications Inc. (VZ) - Spinoff

2007-02-02T16:00:00.000-08:00

Telecommunications giant Verizon Communications Inc. (VZ) announced it will be spinning off it's consumer telephone business in Maine, New Hampshire and Vermont. The divisions will be sold/traded to an existing company Fairpoint Communications, Inc. (FRP). Details on the transaction are as follows:

The Verizon operations being sold would first be transferred to a newly created unit that would issue $1.7 billion worth of new debt before being sold to FairPoint.

Of the $2.72 billion being paid by FairPoint in the deal, Verizon shareholders would receive about $1.02 billion in FairPoint stock. Verizon would receive $1.7 billion, consisting of both cash and an undisclosed portion of the debt securities issued before the spinoff. Verizon would not own any shares in FairPoint after the transaction is completed.

...

The deal with FairPoint is expected to be completed within the next year.

FRP currently has a market cap of $720 Million so this is an absolutely massive transaction for them and for that reason alone, worth monitoring.

Verizon spun-off it's yellow page business to form Idearc (IAR) a few months ago.

These are the type of strategic moves I like to see in a company but I still dislike the underlying businesses. High debt load, commodity characteristics and slow growth, I just can't find anything too attractive here.

Altria Group (MO) - A few more things

2007-02-01T16:10:00.000-08:00

I've been thinking fairly obsessively about the Altria Group (MO) spinoff of Kraft (KFT). This isn't a fully fleshed out post but I wanted to pass on a few things..

1) Excluding Kraft, MO's earnings last fiscal year (ended just a few days ago) and the year to come are as follows:

... Excluding Kraft's contribution in 2006, which came in 2 cents per share higher than we had projected, and excluding certain items, Altria's adjusted EPS last year was $4.05. This year, the company expects earnings from continuing operations, including charges of 8 cents per share, to reach $4.15-4.20 per share, good for about 5% earnings growth. This figure, which is based on constant currency rates, isn't comparable to analyst EPS estimates of $5.62.

Consider that .7 shares of KFT will be distributed for each share of MO. At $34 a pop, this indicates $24 of MO's value is for KFT. Excluding that amount, gives up a per share value of post-KFT MO at $63.50. If earnings come in as expected, you are looking at a P/E of ~15.3. Not bad for a non-cyclical stock with incredible margins.

2) Kraft may receive better debt ratings from Fitch Rating and S&P by removing it's linkage to MO.

Fitch said the removal of Kraft from Altria's umbrella will allow the service to rate the food maker based on its own merits and will not be dragged down by the litigation risk carried by Altria

3) This may be just the start of the special situations at MO.

Next, analysts expect the New York-based company could split its domestic and international tobacco divisions later this year.

Norton believes that could be followed by "monster stock buybacks" worth as much as $40 billion.

"The important thing to bear in mind in our view is that this is really just the beginning of a process from Altria to increase shareholder value," Norton said.

4) Found a reference here to the cost impact to Kraft of lost synergies:

These costs include taxes and shared services, as Altria has been providing some of Kraft's information-technology needs," the analyst wrote. "We guess these incremental costs, which are likely to continue for years, may total 10 cents to 15 cents a share."

So is it a buy? Which one is a buy? Are these good candidates for options? These are all things I am debating right now, all opinions are welcome.

I wrote another post about the spinoff a few days ago here.

Altria Group (MO) to Spinoff Kraft (KFT)

2007-01-31T15:52:00.000-08:00

Altria Group has finally announced that they will be spinning off the remaining chunk of their Kraft ownership (88.9% of outstanding shares). Nothing new here as they have been talking about it for years. The spinoff is to happen on March 30.

From the article:

We continue to view the spinoff of Kraft as a wonderful thing for Altria shareholders but an extremely disruptive event for Kraft shareholders," wrote D.A. Davidson & Co. analyst Timothy Ramey in a research note.

The analyst said that the more than $50 billion of Kraft equity will need to find a home all at once, likely causing an extended oversupply of the company's shares.

"It is such a huge amount of equity, equal to about 40% of all the market capitalization of slow-growth large-capitalization food companies currently owned by institutions and investors," Ramey added.

..

The spinoff also frees up Kraft to pare its portfolio more aggressively. The company has been shedding businesses to focus on core categories such as biscuits, cheese, coffee and refrigerated beverages.

S&P now has a strong buy rating on MO and strong sell on KFT.

If I was a gambling man I would probably buy June MO calls and June KFT puts but such short-term speculation just is not my style.

If anything, I will just sit and watch this one out. If KFT really does get nailed post-spinoff then at some point I would definitely buy. However, at current prices the company seems fairly valued. Kraft is low-growth, already has a ton of debt and expenses are going to rise post-spinoff due to fewer shared costs. The only thing I'll give the company is that margins aren't bad. I am actually fairly sceptical that you will see the much prophesized selling in Kraft shares, given the massive liquidity in the system right now.

Anyways, March 30 is the day, keep an eye on it.

UPS (UPS) - Established a Long Term Holding

2007-01-30T16:51:00.000-08:00

I continued purchasing for my taxable account today, picking up UPS (UPS) at $71.41 after less than impressive guidance knocked the stock back a touch. The company is only predicting earnings growth of 6-10% in fiscal 07 and this has some investors worried. Personally, I think management is just being cautious, and I think that's a good trait. I am buying this stock for the future so I could really care less what happens in 07 or 08 or even 09. So long as the company can perform in the long-run. I will also just mention that if UPS has a bad year, a LOT of other companies are going to have bad years.

My main rationale for buying the stock is similar to Western Union. I think the company has a dominant market position with margins to back it up. The sheer number of drop-off points, the massive logistics system and the brand name are not easily duplicated. On top of that management is buying back stock (~2.75% of outstanding shares last year), paying a dividend of ~2.1%, and staying focused on their core business. There is also a tradition at the company of grooming management from within, in my opinion that tends to accumulate value to the firm.

There is still plently of room for growth in the international market, consider that international revenue was $2.5 billion compared to $8 billion in the US alone. The company is also segwaying into providing supply chain solutions. The results have been less than spectacular to date but I have faith that management will turn it around or else cut it loose (spinoff?).

To summarize, I am buying quality with UPS and for a reasonable price. Not a special situation, not an amazing deal, but it has the potential to deliver. Barring economic ruin, with stock buybacks, dividends, earnings growth and an increase to the PE ratio, I have the potential to double my money over the next 4 to 6 years with reasonable downside. Even better, I can probably hold it for a lot longer than that if I continue to like what I'm seeing. For a taxable account, I think this is a good deal.

NCR (NCR) to Spinoff Data Warehousing unit

2007-01-29T17:13:00.000-08:00

NCR will be spinning it's data warehouse division, Terradata.

NCR, which manufactures a range of products including ATM machines and bar code scanners, said the move should be tax-free and will help each company better focus on their own individual customer base and business strategies.
...
In 2005, Teradata generated $1.5 billion in revenue and $309 million in operating income, NCR said.
...
..is expected to be completed in 6 to 9 months..

Another article adds..

NCR's total revenue fell 2% to $4.55 billion in 2005.

Check out NCR on yahoo here.

The SEC filing on the spinoff is here.

From the SEC filing:

Following the spin off, Bill Nuti will continue to serve as president and CEO of NCR, and Mike Koehler, currently senior vice president of the Teradata Division, will serve as president and CEO of Teradata.

Wikipedia has a lot on teradata here.

A few things from Wikipedia:

The largest and most prominent customer of this DBMS is Wal-Mart, which runs its central inventory and other financial systems on Teradata. Wal-Mart's Teradata Data Warehouse is generally regarded by the DBS industry as being the largest data warehouse in the world

The company has quite a bit of coverage on it's internal website here.

Hedge Hogging

2007-01-29T16:45:00.000-08:00

I just finished reading Hedge Hogging by Barton Biggs the other day. The book was excellent, well worth the read. It is quite succinct but manages to cover numerous investment topics and I think most investors would take something from it.

While it is primarily focused around hedge funds, the book is also an excellent overview of the investment landscape. Value, growth, momentum, charting, gold, macro-economics, the book pretty much covers all the major areas. It is put together using a number of case studies which really drew me in. Not working in the investment field I am always curious how the pro's approach things. What I found from reading this book is that they are not as organized or all knowing as I sometimes give them credit for. In fact, they are very much pushed and pulled by their investors to the point that it may impede their long-term performance.

If anything this book strengthened my view that in spite of the vast number of hedge funds, mutual funds and other investment vehicles out there, there are still inefficiencies in the market. That is the fundamental reason why I invest my money in individual stocks instead of just dumping dumping it into index funds.

I will borrow just one quote from the book, which I found to be particularly insightful:

Tim is convinced that hedge funds, because of client pressure, have become obsessed with avoiding monthly declines in net asset value (drawdowns). As a result they employ stop-loss limits and all kinds of risk-control mechanisms that mechanically make investment decisions for them. Most of these decisions are bad. They never fight the tape and brag about how market neutral they are. As a result, they become short-term, momentum-oriented traders. He argues that this creates an opportunity for an investor who uses leverage, is willing to accept volatility, and who is long term in his thinking. "Accept volatility and concentration", he says. "Diversification is an enemy of performance."

Western Union (WU) - Took a Position

2007-01-28T14:07:00.000-08:00

I established a fairly sizable position, relative to my account size, in Western Union (WU) this week. Western Union is a stock that I had mentioned some months ago when it was first spunoff but which I never actually got into. I've been regretting that decision. It went down right off the starting block and while I wanted a piece I was trying to time the thing. Generally, I never try to time the market, I hate market timers but I did in this case and the stock subsequently took off from $18 to over $24. Well it's started coming back down and I decided to get in when it hit $20.95.

I purchased the stock for my taxable account as I view it to be a solid long-term holding. The company is the dominant player in the North American money transfer business and up there in the rest of the world. It has operaitons in 200 countries, with 285,000 locations. This gives it an advantage of scale and barriers to entry. It earns fat operaring margins of 30%, is growing at ~12% and has a reasonable debt load post-spinoff.

Currently it trades for a P/E of ~18. While this doesn't seem cheap, if the company can perform operationally, continue to grow, pay down debt, repurchase stock basically just take care of business, the P/E will expand. There is no reason that this company couldn't fetch a 25-30 P/E given the 'relatively' low cyclicality. That potential pop in the P/E, in addition to earnings growth (assume 10% per year), share repurchases (2% of net outstanding shares per year), could allow the company to quadruple in size over the next 10 years. That would translate into yearly annual gains of ~14.5%. In reality, the results will differ materially from my expectations but potentially in either direction. For a taxable account where I don't want to be trading, I view the likelihood of the results and the potential returns excess over fixed income to offer an atttactive entry point.

Beyond that, check out the latest quarterly results here.

Triple Crown Media (TCMI) - Sold Full Position

2007-01-28T13:49:00.000-08:00

I sold my full Triple Crown Media (TCMI) position on Friday for $10.01. I didn't make a spectacular amount of money off of it but I have become increasingly less interested in the stock.

I haven't seen a whole lot of insider purchasing of TCMI recently. That kind of concerns me. I mean the stock has doubled off of it's April lows in the $5 range and no insider buying on the way up.

Also, I haven't seen the aggressive debt reductions or operational improvements that would justify staying with the position. In fact, debt got loaded up a little further, from $149 M net liabilities to $164 M. TCMI also purchased Pinnacle Sports Production in the most recent quarter. As an investment, I don't want a company this loaded with debt to be making acquisitions. I wanted to see a strengthening of financials and improvements in the core businesses. Check out the latest quarterly report for the details.

I bought into TCMI at $7.41 on August 16/06 and sold it at $10.01. That makes for a profit of 35% on the transaction.

Morgan Stanley (MS) to Spinoff Discovery

2006-12-20T20:14:00.000-08:00

Just a quite note that Morgan Stanley has announced it will be spinning off it's Discover credit card unit. From the article:

The move comes as rival Visa International plans to go public in 2007, following in the footsteps of Mastercard Inc.'s banner listing earlier this yea
..

Morgan Stanley Chief Financial Officer David Sidwell said the outlook for Discover is bright. The announcement of the spinoff comes at a time where credit card companies are white hot -- Bank of America Corp. earlier this year acquired MBNA Corp. for $35 billion, and shares of Mastercard have doubled since their May 2006 debut.

Discover's fourth-quarter profit more than tripled to $199 million. By comparison, Morgan Stanley's retail brokerage profit rose to $171 million from $84 million last year.

The spinoff is expected to cost Discover up to $50 million in higher funding and overhead costs. The spinoff is expected to add up to $95 million per year in costs for Discover, and the company sees some $40 million of overhead savings annually.

Apparently, the spinoff may result in a downgrade to the new unit's credit rating:

Moody's said it will review what effect the "removal of implied parental support from Morgan Stanley" would have on Discover's credit.

Fitch Ratings said it may downgrade Discover's debt because the credit card issuer's credit is tied to support from its parent.

Standard & Poor's said it isn't considering downgrading Discover's debt because it thinks Discover's business prospects are unchanged.

Too early to give much of an opinion on this one. Let's see how it prices.

Information Collection

2006-12-20T19:57:00.000-08:00

There is a vast quantity of financial information out there on the internet. The process of scanning through this information to find stocks that interest you can be quite daunting. Personally, I don't really have a single method to obtain special situation info. I mean I go to blogs, scan yahoo/google finance, read Business Week/Fortune/Barrons, do searches with google, it takes a LOT of time. So anytime somebody can suggest a method to optimize the search process I am all ears.

Alex Bossert sent me an email with a few good links. Actually the first and last link are more than just links, the parameters in the URL initiate searches on the SEC website. You still have the process of clicking on all the links and scanning through the documents to figure out the scoop but this is still faster than many other methods. Well anyways, here is Alex's email:

I have a few reasources that you might find interesting to help find special situations.

These are the sites i use:

tender offers:

This site profils special situations often:

http://www.fatpitchfinancials.com/

Going private transactions can sometimes be very rewarding:
Going Private Transactions

If anybody else has any suggestions on methods to search for special situations I would love to hear them.

South Street Financial Corp (SSFC) - Buyout Arbitrage

2006-12-14T17:17:00.000-08:00

Thanks to Michael Guzzo for pointing out a good arbitrage opportunity on his blog. The arb is on a tiny bank South Street Financial Corp (SSFC). The company has recently announced it's plan to delist in order to cut costs. That doesn't really interest me too much. What I did find interesting was that (as pounted out by Mike) in their announcement they have indicated that shareholder of less than 750 shares will be converted to preferred shares on a 1 to1 basis. The preferred shares can then be converted for $10 per share each. Currently the stocks are trading in the low $9 range, offering a decent arb return should your account be small enough to benefit within the 750 share limit. In my opinion, it is this 750 share limit which is keeping the share price down as the usual special situation players, hedge funds, probably couldn't be bothered with this one. In fact, most instiutional holders would be motivated to sell due to the delisting and subsequent absence of reporting.

Where it gets a bit dicey is the date of the transaction and whether or not it will go through. Apparently there will be a special shareholder meeting in March, during which the delisting move will be voted on. At this point, I really don't have a very good feel for how long it will actually take to delist. On top of that, it is unclear whether or not the vote will go through.

In spite of these concerns, I am going to add SSFC to my own portfolio but won't be tracking it on the blog since it is such a small gain. In my opinion, the vote will probably go through as presumably management has talked to some of their larger shareholders about the deal. If the vote fails, well SSFC was pretty much trading in this range before the announcement so I see little downside. I am hoping that the transaction can be concluded in 3-6 months after the vote but that is pure speculation on my part. The company pays out a dividend of $.10 per share per quarter, so I will be getting over 4% while I wait. Considering that I bought my shares today at $9.08, I should get a 10.1% capital gain plus the dividends. I consider this an attractive and relatively safe arbitrage.

Disclaimer

Do your own research on this and all securites mentioned on this blog. I am in no way recommending or endorsing this or any securities discussed on this blog. All information on this blog is purely my opinion.

Update

I have been thinking quite a bit about the timing for the repurchase of the preferred shares. What I have concluded is that this would probably need to coincide with the application for delisting but could actually take place (this is speculative on my part) before all the actual paperwork goes through. The key component seems to be that the company has fewer than 300 shareholders to get delisted. It would seem then, that in order to reduce the number of shareholders the conversion to preferred shares would take place first.

In other words, it is my opinion that I will be able to exit out of this position a little earlier than I originally anticipated. If the vote goes through, then perhaps 1-3 months would be more accurate. At any rate, this is looking like a better and better play the more I dig into it.

A couple of references:

General information on going private. The article mentions the 300 shareholder limit and a 3-week wait for delisting. Deregistration takes a bit longer, the SEC has 90 days to approve this. In the case of SSFC preferred shares, I do not believe it is an issue as the preferred shares should be issued prior to de-registration.

A press release from Bennet Environmental which is filing to delist from the Amex. The press release was issued on Nov 22, requesting delisting take place on December 14.

Take Two Interactive (TTWO) - Sold Out Position

2006-12-14T16:01:00.000-08:00

I sold my entire position in TTWO today, for $20.14 per share. I originally got into TTWO in August at $10.62 per share. Excluding transaction costs, this resulted in a gain of 89%.

My reason for selling was simply that I thought the stock got ahead of itself. Very little has fundamentally changed since August. There is still an ongoing investigation, the company may still be de-listed and they have yet to product a new blockbuster (although Bully is doing quite well). The market, in it's mania, just got very excited about video game companies recently. For the stock to go up 89% when so little has changed just doesn't make any sense to me. Hence I sold out.

Now this is not to say that Take Two is a bad company, it just isn't a bargain anymore. I would love to see it dip down again and would take a new position. In the meanwhile I'll look for other opportunities.

Medtronic (MDT) to Spinoff Defibrillator Unit

2006-12-12T17:13:00.000-08:00

Medical device manufacturer Medtronic has announced that it will be spinning off it's external defibrillator business. Apparently the main motivation is to shed slower growing operations. The spinoff has potential as the new company will be quite small compared to Medtronic. The new company is expected to have a market cap of $700 M to $1 B compared to Medtronic's $62 B market cap. It is possible that some institutional selling will ensue as the new company may not make it into the major indexes. The spinoff is expected to be completed in the first 6 months of Medtronics 2008 fiscal year, which starts in May.

From the article:

Medtronic Chief Executive Art Collins said the company's board chose to spin off Physio now so the parent company can focus on devices for chronic diseases, in markets with larger profit margins and more growth potential than defibrillators. The Minneapolis-based company, with a market value of $61 billion, makes a wealth of devices ranging from cardiac pacemakers, to neurostimulators, to insulin pumps.

Physio-Control believes it will have more control over its own destiny as an independent company, and will be able to attract more investment for its Lifepak line of products, said Webster. The division will also presumably have more stable management than in recent years, when it became a revolving door for up-and-coming Medtronic managers.

...

Physio-Control will now compete directly with several companies in the defibrillator market, including giant Philips Medical Systems, Zoll Medical and Bothell-based Cardiac Science.

Debt and the Ratings Agencies

2006-12-09T07:35:00.000-08:00

Found a good article on the power that Ratings Agencies such as Moody's and S&P are currently wielding over general investors. The article points out that just a few years ago, during the bust, their was a lot of investor hatred towards these companies. However, now that the economy is steaming along all seems to have been forgiven in spite of the fact that nothing has fundamentally changed. I know, I know, fairly typical wall-street stuff but just a reminder to always be vigilant.

A few good points from the article:

At the same time, the agencies have been generating higher revenue by rating complex debt instruments called structured finance. Moody's revenue from structured finance increased 30 percent last year, while those from corporate finance rose only 7 percent, Peters wrote. Similarly, structured finance ratings contributed 40 percent of 2005 revenue growth at S&P.

That renews the question, "Are they willing to 'bite the hand that feeds' going forward? We think probably not," Peters wrote.

...

"Frankly, it is unhealthy for a $20 trillion tradable credit system to be subject to the whims and vagaries of the ratings agencies, no matter how well intentioned they may be," Peters wrote. "Last spring's correlation hiccup and market disruption on the heels of ratings downgrades in the auto sector is just a sneak peek of the credit world to come, in our view."

Anyone who has read this blog for awhile will know that I am not the hugest fan of debt and this just further strengthens my opinion. Debt levels keep ballooning, banks are reducing their reserves a a percentage of liabilities, equity overloaded with debt is barely marked down, it just goes on and on. I think ultimately their will be a price to be paid for this. As the value-investor saying goes, I don't have a crystal ball, but I do know a couple of things. Inflation and interest rates are at low points not seen since the fifties. Ultimately if interest rates were ever to rise, which sure as hell has happened before, a lot of these overloaded junk stocks & associated bonds that keep getting floated are in a lot of trouble.

This is not all a doom and gloom post. You will notice I said previously that companies which are overloaded with debt don't seem to be marked down sufficiently. Well by that same logic companies which are in good financial health are not being marked up enough relative to their debt-burdened peers. I think that if there is any general category of value in the market right now, this is where it is at. High quality companies with good finances are being treated like garbage by the market. Many hedge fund managers even go after them to raise more debt! I mean there is actually a derogatory term for low-debt companies, 'under-capitalized'. Well I'm not buying into Wall Street's obsession with debt. Too much of it is piggy, short-term thinking where the firms are only considering their own goals with no regard to what the future may hold. No matter what these types say, a strong balance sheet is still a good determinate of value.

Apollo (APOL) - Purchasing Shares

2006-12-07T16:39:00.000-08:00

Just a note that after all the commentary and a little more review on the situation, I have got to the point where I have committed some capital to Apollo. For the record, I got in today at $38.62. I feel that this is a decent (but not outright dirt cheap) entry point for a fundamentally high quality company. That being said, do your own research on this and all stocks mentioned on this blog.

Duke Energy (DUK) - Spinoff a Potential Catalyst

2006-12-02T15:14:00.000-08:00

Business Week draws out the argument for why Duke's impending spinoff of it's natural gas business may be a boon for the stock. According to Daniel Ford who advised on the spinoff:

The "narrowed management focus, more efficient use of capital, and removal of what appears to be a conglomerate discount on Duke's price will fuel expansion [for both companies],"

He goes on to peg a valuation to Duke:

Ford says that, on a sum-of-the-parts basis, Duke is worth 21 a share, and the gas spin-off 14.

Consider that the stock has traded in the $26-$32 range and it's rated post-spinoff at $35. The stock finished trading on Friday at $31.69, so it will seem the potential upside is less significant than the downside. I personally am going to sit this one out. In spite of my negative opinion given what I have been seeing with the last few spinoffs (WU, SBH, HBI), I would not be surprised if this is a money-maker.

With many spin-offs, the sum-of-the-parts have actually traded several percentage points higher the very day that the spin-off occurs in spite of the fact that the transaction was announced months in advance. How this works absolutely dumbfounds me but there has been easy money to be made on these deals. However, I am just not that kind of investor. Until I see a company being spun-off that is actually reasonably priced and has promising business characteristics I will wait. I already have natural gas investments through Apache and given my inability to pick commodity prices that is enough exposure for me.

Apollo (APOL) - Potential Turnaround

2006-11-28T15:39:00.000-08:00

I ran into a good stock-pick article containing value/contrarian Jeff Auxier's opinions. In the article, Jeff mentions that he is currently buying Walmart (WMT), Western Union (WU) and Apollo (APOL). Walmart has been coming up in a lot of value discussions ever since Warren Buffet bought into it. Western Union was spun from First Data Corp. and certainly has promise. However, the stock that caught my eye was Apollo.

Apollo runs a number of universities and online education programs for working adults looking to upgrade their education. A former dynamite growth story, it has ran into hard times of late. Enrollment growth has dramatically fallen to ~5% a year, advertising expenditures are far exceeding that level and there have been investigations into stock option grants (who hasn't had these stock option problems lately?) which have resulted in an upper management shakeout. The stock currently trades for roughly half it's 52-week high with a P/E of 14.9.

Jeff's main argument is that Apollo is an industry leader hitting a cyclical downturn. The numbers would generally seem to confirm it's spot in the industry. The company sports profit margins of 17.7% and ROE of 62.97%. There is virtually no long-term debt. Most of it's competitors are also hitting hard times.

The company also may provide certain recession counter-cylicality. In effect, as the economy worsens (if it worsens) jobs become scarcer and people get layed off. Looking for new or better jobs people return to school in greater numbers and companies like Apollo benefit.

At this point I am still investigating the stock. I need to convince myself that the drop in growth rates is actually going to turn around at some point. For those who need fewer reassurances or have more insight into the company this could be a good buying opportunity.

Obviously, I would love to get some feedback on Apollo.

Indus International (IINT) - Arbitrage Situation

2006-11-27T19:27:00.000-08:00

Indus International (IINT) has received a prived equity buyout offer of $3.85 per share. The article states that the deal was expected to close in 90 days, that was on October 23. IINT is currently trading between $3.74 & $3.76. If you can get in at $3.74 you would be looking at a 2.9% return (19% annualized) if the deal went through. If the deal falls apart though you're pretty much screwed. The stock was trading at $2.52 prior to the announcement so there is tremendous downside.

I personally don't have the type of funds for such a small arbitrage to be profitable so I will sit this one out. Do your own research before even thinking about this one. Thanks to the vinvesting forum user who pointed it out.

Sally Beauty Holdings (SBH) - Spinoff Analysis

2006-11-26T20:20:00.000-08:00

Sally Beuty Holdings (SBH) was spun-off from Alberto-Culver (ACV) last week. The stock had a great run in it's opening week, rising from an initial $7.35 to $8.65. However, after having a look at the sec filings, I am going to stay clear of this one.

My problem with this one is that SBH has a massive amount of debt to the tune of $1.85 billion. This compares with $2.25 billion in sales and operating income of $192 million at the company last year. I do now know what interest rate SBH will be paying on the debt but in general, junk rated debt goes for ~10%. It is possible that SBH has better interest rate terms but if so probably only by 1 or 2%. What it comes down to is that the interest payments alone will eat up most of the operating profits. After taxes you are not going to be looking at very much booty.

Now there are several ways for a company to deal with large debt-loads. You can pay it off, you can grow and thereby reduce it's relative size or you can simply wait and inflationa will gradually reduce the debt's relative size. Obviously the last item is only an option for governments. SBH is likely planning some combination of the first and second options but it seems that this is going to require considerable time. If my analysis is correct, SBH has very little funds left after paying the debt and so paying off a debt of this size will take a very long time. Start thinking in terms of years. SBH has no choice but to grow their way out of the debt load, hopefully reducing it as they go.

When you look at the company from the perspective of growth you are just not getting that much of a bargain relative to the risks associated with the debt. From 2001 to 2005 SBH grew at an average rate of just over 11%. For the past 9 months, the rate has fallen to ~5%. This represents a fairly average growth rate and as such an average P/E, perhaps in the 14-17 range given the lack of a moat. At current prices, SBH has a market cap of ~$1.53 billion, against net income for the first 9 months of the year (prior to the debt-load coming into the picture) of $108 million excluding special charges. Extrapolating the results out for the full year (past results indicate there is little seasonal effects so I just multiply by 1.33) provides a P/E of ~10.7. So excluding all of the interest payments the company might be worth 30-60% more. Including all of the debt the earnings drop closer to nothing and the P/E is ridiculous.

Let's look at a quick scenario to see just how much growth can improve the situation. If the company can continue to grow revenue and profits at 11% (historically the profit growth has considerably lagged revenue growth so this is questionable) then in 6.5 years time earnings will have doubled. Let's say that the company has reduced the debt from $1.85 billion to $1.5 billion. This assumes they are putting a considerable sum of the growing earnings towards debt repayment. Let's also assume, very optimistically, that the company's debt load is only 8%. Even in this fantasy model, the company would have earnings of $170 million and might warrant a market cap of $3 billion (P/E 17.5). In that case you would have doubled your money after 6.5 years. However, if the company takes out more debt, issues new equity, grows slower than expected, if interest rates spike, if anything goes wrong at all I can't see this turning out well. Where is the margin of safety?

Another item that caught my attention is the external investments that were made into the spinoff. Independant investors contributed $575 million to SBH allowing it to pay out a special dividend. In return they recevied 47.5% of the company. The remaining ownership of the company went to ACV shareholders via the spinoff. At present prices, their $575 million investment has already grown ~26% to ~$725 million. One of the few positive points I might have drawn was these assumedly institutional investors willingness to invest such a large sum. However, the fact that current prices considerably exceed their entry point makes me question the validity of that argument.

To any investors who got in on the ground floor of this one, I salute you. You have made a good and quick profit. However, the debt-load and earnings on this one just don't seem weighted in my favour. Not at these prices. Much as it pains me to do so, I will sit out another spinoff.

Disclosure

I do now own shares in ACV or SBH nor do I plan to buy any.

Do your own research on this and all stocks mentioned on this blog.

Guitar Center Inc (GTRC) - Growth at a Reasonable Price

2006-11-22T15:15:00.000-08:00

First off, let me say that while this is a stock idea, it is not a special situation by any means.

The Company

Guitar Center Inc (GTRC) is a retailer in the music equipment industry. The company operates 3 different store types (2 tradional and 2 online) which taken together pretty much run the full gamut of different musical equipment. Guitars, drums, band, DJ mixing, lessons, used goods, they got it. Even more critical, many of these products are not heavily retailed by the big box behemoths. GTRC is in somewhat of a niche and fragmented market albeit with a relatively small moat.

The company currently operates 194 'Guitar Center' stores in 40 states, ~90 music and arts locations as well as 2 online retail sites. The company still has room for continued expansion in the US and the international market has not been touched. In addition they can segway into new musical segments, as they did by purchasing the Music & Arts division which is in the band instrument and education segment. Management is forecasting long-term revenue growth of 13-15% and earnings growth of 18-20%. While these number are no doubt optimistic, the company has a history of consistent growth going back to their IPO in 1997. Revenue growth over the last few years was ~17% before slowing to ~12% in the most recent quarter.

Financials

As of the third quarter report, GTRC has net tangible assets of $464 M or $15.51 per share against a share price of $43.35. The company recently paid off $100 million in debt, leaving no long-term debt oustanding. However, be warned that the majority of their tangible assets are in the form of inventory. In the rare event of bankruptcy I would not expect the liquidation value to be anywhere near the current tangible book level.

Based on the lower end of their forecasts, net income for the year should run around $2.50+, fully diluted. That is the main sore point for the company and the reason the share price is at $43 instead of it's 52-week high of $57. Earnings were hit by the inclusion of stock-based compensation expenses, increased ad and promptional expenses as well as additional overhead as the company expands into new markets. In general, earnings levels are my biggest concern with the company. Currently they are averaging around 4% of revenue and while this is an improvement over the high 2%'s they were getting in years past it is still quite low. Even bulk-retailer Walmart sports higher net margins at 5.8%. By buying this stock you are effectively betting that as the company continues to grow, the scale effect and cost savings will enable it to expand margins. That is what management is forecasting, as mentioned previously, when they peg earnings growth 6% higher than revenue growth.

While the net earnings are nothing to get excited about, ROE came in at 15.8%. While the company doesn't earn great profits based on it's sales, it does generate large earnings relative to the capital required to do so. What this means is that the company doesn't require a lot of equity to grow and hence going forward shouldn't require taking on debt or issuing new shares.

A Few More Things

The balance sheet was one of the first things which caught my eye on GTRC. The lack of long-term debt says alot about the type of management running the firm. Clearly, with nearly $2 billion in sales they could borrow more and expand faster but they have avoided that urge. This type of disciplined approach is something I look for in companies as it leaves room for future contingencies. My opinion was further strengthened by the reasonable, steady rate that the stock has grown at over the past 9 years.

One of the issues that I had with this stock was 'what is going to happen to it if there's a recession'? Isn't the consumer about to die after all? Well it's certainly possible but the company handled the 2001-2002 recession admirably. In fact looking at the numbers you wouldn't even have been aware that there was a downturn. Have a look at the company's revenue since it's IPO (this type of consistency is somewhat rare and usually deserves a premium price):

2005 - $ 1,782,499
2004 - $ 1,513,172
2003 - $ 1,275,059
2002 - $ 1,100,889
2001 - $ 949,284
2000 - $ 794,786
1999 - $ 620,081
1998 - $ 487,714
1997 - $ 367,353

Conclusion

My primary motivation for purchasing GTRC is that is is reasonably priced, has proven it's ability to grow, is in a niche and seems well managed. The biggest risk, in my opinion, is the company's ability to manage expenses and widen profit margins.

I am not banking on quickly doubling my money or seeing any type of event which will spike the stock higher. Not that those type of events couldn't happen, they certainly could, but this is a longer-term investment based on fundamentals. I simply feel that at current prices, GTRC is a stock which will continue to grow and will beat the market over the next 4-6 years.

Disclosure

I purchased shares in GTRC today at a price of $43.65.

Do your own research on this and all stocks mentioned on this blog.

Samsonite (SAMC.OB) Announces Special Dividend

2006-11-21T19:37:00.000-08:00

Luggage producer Samsonite (SAMC.OB) made a major announcment today causing the stock price to soar 20% to $1.11. There are a number of elements to the announcement but I feel the following are the most critical:

1) The company, with a current market cap of $252 M intends to issue a special dividend of $175 M. The dividend is contingent on the company's ability to obtain over half a billion dollars in loan financing.

2) The company has sizable preferred shares outstanding and over 90% of the holders have agreed to convert to common equity if the special dividend goes through.

If all preferred shares were converted ~480 M shares would be produced, against a current base of ~230 M shares. Obviously this will heavily dilute the existing share base. There are also sufficient options & warrants to purchase ~85 million shares. All told, full warrant/option/preferred share conversion would result in the share count shooting up to 770 M from 230 M. At this maximum number, existing shareholders would receive $.227 per share or a payout of approx %20.4 at current prices.

On the flip side, the preferred shares convert at $.42 per share. If all 480 M converted, the company would rake in ~$200 M, more than sufficient to cover the dividend. It should also be noted that the preferred shares have $42 M in dividends owing. It is not clear to me whether this value would be erased with conversion.

3) The company is attempting to repurchase ~$300 M in bonds. The repurchase is contingent, again, on it's ability to obtain the half-billion in new loans I referred to in point 1. While they do not explicity make clear the reason for the debt swap I would assume it is in an effort to refinance at a lower rate.

To summarize, this is neither a buy nor a sell idea. I will continue to watch Samsonite but at this point I am just passing on the analysis I have already done. I currently have no intention to buy Samsonite stock and do not currently own any.

Updates: TTWO, WEN, WZEN

2006-11-17T15:55:00.000-08:00

Well just thought I would go over some of the more recent events that have affected the stocks I follow. Here goes:

Take Two Interactive (TTWO) - Take Two Interactive has had a hell of a week. It started trading at $16 and was over $18 yesterday. Sony's PS3 is coming out, word is out that ICahn upped his stake to 2.9 million shares from 800k, and investors are just getting pumped on video game companies in general. I already mentioned it before but there latest game Bully is no slouch either. However, at this point I wouldn't buy anymore. I am not going to sell either but those of you who are short-term probably should consider it. TTWO still has some large issues and it could take awhile before sales turn around. In the short-term the stock could head just about anywhere. However, due to tax reasons as well as my fundamental belief that the company can produce quality games and overcome existing legal issues I am going to hold. Just be aware that it is not cheap and that my reasons for holding it are more subjective than purely analytical.

Wendy's (WEN) - Announced that the full 19% of outstanding share for a modified Dutch auction have been tendered. In other words, it looks like the previously announced share repurchase will go through. The company will be scooping them up at $35.75, or towards the top of their target $33-36 range. The market socked WEN on the news, bringing it down over 6%. I consider this a buying opportunity. While I would have preferred a lower average purchase price, I still think the deal is in existing shareholders favour and I will continue to hold my shares.

Webzen (WZEN) - The company got whacked this week. An anlalyst downgraded the stock to neutral and the stock closed down at $3.59. There was also an announcement that there upcoming online game, Soul of the Ultimate Nation, will be provided free with revenue coming from purchases of in-game items or micro-payments. I don't imagine most Wall-Streeter's could get too excited about that. However, this can be a successful model as the upgrades are generally priced quite cheap and players regard extra purchases as insignificant. You can also generate a keeping up with the Jones atmosphere. At this point, I think you have good risk/reward. Now there are a real risks with this one, well with any stock really, that things may not go as planned. However, you're buying for just over book and any reasonably successful game should cause the stock price to soar.

Do your own research on these and all stocks mentioned on this blog.

Mueller Water Products Inc. (MWA) - Spinoff

2006-11-14T15:35:00.000-08:00

Mueller Water Products (MWA) will be spun off from Walter Industries (WLT) in mid-December of this year. MWA is, as you may have guessed, in the water infrastructure business. Walter Industries will be left with coal, homebuilding and financing divisions.

The situation is a little more complicated than just the spinoff, and has a bit of history. WLT originally acquired MWA in Oct, 2005. Then, WLT IPO'd ~25% of it's MWA shares in June, 2006 at $16 / share. The remaining 75% of the stake will be dished out in the spinoff to WLT shareholders that I referred to previously. It is a just bit more complicated in that there are also some preferred shares which can be converted to WLT shares and receive the spinoff shares. Also, the new shares that will be issued in the spinoff have greater voting power. These new shares will control 96% of the voting power while making up 75% of the equity interest. Shares are currently going for $13 and change. So from a special situations vantage point, at first glance it looks like you have a confusing situation and may have some institutional selling and down pressure on the stock.

I found a quote on the number of shares that will be distributed to WLT shareholders. I believe the range is due to the preferred shares.

Walter Industries holds all of Mueller's nearly 85.9 million Series B shares outstanding, but plans to spin them off to shareholders by the end of year, a company spokesman said Tuesday. For every share of Walter Industries, shareholders will receive between 1.6 and 2 shares of Mueller, he added.

Unfortunately I am not sure convinced that the institutional selling is unwarranted. There are some legitimate issues with the deal. For 1, MWA is heavily tied to the housing market as much of it's business revolves around new construction. I haven't actually crunched the numbers but have seen estimates of ~50% of revenue from new construction. Obviously this should be a bit of a concern as a housing slump seems inevitable. It is more a question of how severe it will be. The company is also tied to government spending to upgrade water infrastructure. As you may imagine, this can lead to very lumpy and unpredictable results. Finally, the existing MWA shares have little voting power. I am not sure how much weighting to give the votes in terms of price but certainly I would rather having voting than non-voting shares.

From a financials perspective things are also mixed. The company has about negative $500 million tangible assets so you don't have much support there. Recent profits have been next to nothing but should improve as the company gets over restructuring and pays it's debt down. Excluding restructuring and other 1-time items the company has operating income of about $275 million against a market cap of $1.56 billion. That in itself would be a sweet ratio to jump in at but the fact is there is additional restructuring and a lot of debt repayment ($1.1 Billion long-term debt outstanding) remaining.

Where I am at with this one is basically nowhere. I have done enough research into it (I feel) that it doesn't look CHEAP at this point. Not that it's expensive, will under-perform or anything like that but it's not outright cheap. I just don't buy stocks unless I think the risk/reward ratio is tilted in my favour or I have some special insight into the situation. Neither condition occurs here.

Another blogger, ControlledGreed, is bullish on MWA. You can view his rationale here. He also has another article with some insightful comments on the situation here.

Comments

2006-11-14T11:02:00.000-08:00

It has recently come to my attention that not all readers are able to post comments. Apparently, I had a checkbox turned on which limited comment posting to blogger accounts only. At any rate, this issue should now be resolved. I am not sure if anyone was affected by this, but if you were, then believe me, I genuinely am interested in feedback. Post at will.

The one caveat is that the comments get moderated by me. This is just to prevent readers from being subjected to SPAM. I am quite happy with my sexual virility so I just don't need these types of messages. However, beyond completely off-topic SPAM I will put the comments through, regardless of my opinion on them.

Joel Greenblatt's Stock Picks

2006-11-13T10:55:00.000-08:00

For those of you new to special situation investing Joel Greenblatt wrote the special situation bible. If you ever get a chance, I highly recommend "You can be a stock market genius" by My. Greenblatt. It has an amazingly bad title but is an absolute gem. In spite of the title, this is not some cheesy, you can make a million dollars with only $1 down and zero-effort book. It is actually quite detailed and clearly points out that this type of investing takes A LOT of work. Slackers will not be rewarded. Joel covers a number of special situation topics in the book: spinoffs, bankruptcies, tracking stocks, etc. and provides a number of detailed case studies for each.

Well anyways, if you have any respect or interest in what Joel Greenblatt is doing, there is an article on some of his recent stock picks here. The article is quite short and doesn't provide any insight into why he might have chosen the stocks, so that is up to us. Of the stocks on his list, I have been watching Claire's & Autozone for awhile but just never pulled the trigger. Anyways, here are his picks:

Autozone (AZO) - Huge turnaround was perfomed on it by Ed Lampert, the guy who is making Sears owners rich. My big problem with this one is that he may have over-emphasized cost-cutting to the point where the store's reputation is starting to suffer. Also, you have already seen substantial appreciation here.

Aeropostale (ARO) - I don't know anything about this one.

Claire's (CLE) - Good turnaround candidate. The stock sells for around 16x trailing earnings and is still growing. Maybe I'll write an article on it 1 of these days.

Services Acquisition Corp (SVI)

2006-11-10T11:41:00.000-08:00

A reader, Adam Chud, brought to my attention Services Acquistion Corp (SVI). While the situation isn't really for me, it does have potential so I thought I would pass it on.

SVI is a "blank check company", formed and financed with the sole intention of making a promising acquisition. The company has had it's sights set on smoothie-maker Jamba Juice since March. This is essentially a buyout labeled as a merger. SVI will take control of Jamba for $265 M in cash.

To obtain the cash they have a PIPE agreement with a number of hedge funds (including Soros Strategic Partners) and other investment firms whereby 30 odd million shares will be issued for $7.50 a pop. This was negotiated back in Spring of this year. On top of this, there are a number of outstanding warrants which will cause further dilution at $6 per share. All told, if all warrants are exercised, after the deal goes through you will have ~66 M shares outstanding, and ~$200 M cash remaining with no substantial liabilities. SVI, is currently trading for around $10.90/share, so this will give you a market cap of $720 million, offset by the $200 million in cash

In the year ending, June 2006, Jamba had $253 million in revenue, $6.7 M operating income, $3 M net income. Revenue has been growing at roughly 20% / year over the last 4 years. So at current prices you are paying close to 3x revenue for a 20% grower but with little earnings.

This is where I get stumped on it. 3x revenue is not bad, especially if management can turn earnings around which seems likely. SVI management has previous experience with Blockbuster and seems capable. However, at current prices there just doesn't seem to be the fat discount I like to see. To see a significant pop you are going to have to have a continuation of the 20% rev. growth and a turn-around in earnings. On the flip-side you have a long-ways down should the deal fall-through or the company turn out to be a dud. However, do your own research, if Jamba reallly is a killer franchise this would be a great opportunity to get in at a reasonable price.

Motley fool has a great and free article on SVI here.

You can get some good info on Jamba and the details of the deal from SEC filings here.

Public Service Announcement

2006-11-09T15:50:00.000-08:00

In general, I try to stay away from macro-issues on this blog. I find that there are too many factors that affect the big picture to be able to make any sort of meaningful comment. However, I ran across an article today on the trade deficit and I can't resist commenting. The title of the article is "Trade Deficit Narrows to $64.3B in Sept.".

If I was writing the article, I would have named it "Trade Deficit Continues at Unmaintainable Levels". I think that any wording which puts a positive spin on the trade deficit is misleading and can only lead to harm. The only reason the deficit even dropped was due to the decrease in oil prices. The fact remains that the trade deficit is running at a level of approximately $2500 per American per year. Children, elders, everyone included. Nobody seems to be doing anything about it. Writing this blog is the 1 thing that I can do.

For those who don't follow him, even Warren Buffet is alarmed by the trade deficit, and is hedging his bets by investing in foreign securities. Warren Buffet is the second richest man in America (if not the world) and is probably the greatest investor ever. Have a look at his 40-year record if you don't believe me.

HanesBrands Inc. (HBI) - A Further Review

2006-11-07T10:14:00.000-08:00

Apparel manufacturer HanesBrand (HBI) released earnings last week, AP writeup here. I have been watching the company from the sidelines since Sara Lee announced that they will be spinning it off. I did a bit of analysis on the company as part of my never-ending quest for a reasonably priced investment. Here is a summary of some of the key points:

Earnings came in at .52 / share, down from .86 / share in the year prior. Earnings in the most recent quarter were impacted by the spinoff from Sara Lee & restructuring charges. Excluding the charges and factoring in taxes, I estimate that earnings would have been closer to .72/.73 per share. Restructuring charges are expected to be $250 million over the next 3 years.

Revenue decreased by approximately 2%. The company attributes this to the exiting of low-margin businesses and reduced sales of sheer hosiery.

The company now has a huge debt obligation of 2.5 billion against a market cap of 2.16 billion. If you exclude goodwill & intangibles the company has negative book value. The loan was only serviced for 3.5 weeks of the last quarter due to the timing of the spinoff. Going forward, of course, the loan will have to be serviced for all of the quarter. Annual debt payments are going to run ~$260 million, or ~$65 million per quarter.

The company is forecasting sales next year of ~$4.5 billion and operating margins of 9.5%. This should result in operating income of ~$425 million. The debt financing would reduce that to ~$165 million. Assuming restructuring charges are split evenly (they won't be but it will average out over the full 3 years) and that the company forecast them correctly, income would be further reduced to $80 million. Taxes will cut that down to about $55 million.

Another way of looking at it is just to ignore the restructuring costs. This would give you net income of ~$110 million. Against a market cap of $2.1 Billion, this still isn't that attractive.

The one bright spot, is that Hanes Brand is still not attracting much analyst coverage. From the article:

Due to its new independence after the spinoff, Hanesbrands is only followed by one analyst, so no accurate Wall Street estimates are available. Credit Suisse initiated coverage of the company Sept. 6 with an initial rating of "outperform."

My final conclusion? HBI is a well-run company with decent products. They should certainly be able to handle their debt payments and even slowly trim it down. However, for the foreseeable future, it is not particularly cheap. Relative to the valuations on many other stocks it seems more reasonable, so if I just had to put money into the market I would probably put a little into HBI. However, fact is, I don't have to buy anything if I don't want to. For now I will remain on the sidelines.

I wrote another article on the Hanes Brand spinoff, here.

Disclosure:

I have no position in Hanes Brand or Sara Lee.

Duke Energy (DUK) to Spinoff Natural Gas Business

2006-11-06T17:36:00.000-08:00

Duke Energy (DUK) has announced it will be spinning off it's natural gas business. The new company is expected to be separated on Jan 1,2007, will be named Spectra Energy and should trade under the symbol, SE. Duke will be left with it's electrical utilities.

From the article:

Once the separation is complete, Spectra Energy, which will be based in Houston, will consist of the business unit now known as Duke Energy Gas Transmission and Duke Energy's (NYSE: DUK - News) 50 percent ownership interest in Duke Energy Field Services, which recently announced its new name -- DCP Midstream.

..

Spectra Energy will operate primarily in three sectors of the natural gas industry: Transmission and storage, distribution, and gathering and processing.

Comments or opinions on the spinoff are welcome.

BancInsurance Corporation (BCIS) - Quarterly Results

2006-11-03T16:51:00.000-08:00

BancInsurance Corp (BCIS) is a micro-cap specialty insurance company. I originally wrote a fairly bullish post on them here. The company released their quarterly results a few days ago and I still find the company to be under-valued.

The company actually came out with strong earnings numbers of $.42 / share against a $6.10 share price. This, however, is mostly attributable to the sale of a division. Without this one-time item earnings would have been approximately null. The combined ratio came in at 100.9%, ouch. Finally, premiums earned declined from $13.7 M to $12.4 M. That, in a nutshell, is the bad news. Let's move on.

First, while the combined ratio at over 100% is unmaintable, this included results from their bond operations, which have been discontinued. This is not altogether unexpected and the company has been working to exit out of this business. Without this division, the combined ratio would have been closer to 95%, not great, but maintainable.

The decline in premiums was mostly attributable to a large account which was lost. There is going to be some lumpiness in this business and a single quarterly does not necessarily reflect a trend.

Another discontinued business arbitration was resolved in the quarter. This leaves only 1, from the original 4, and should minimize the losses going forward. This in turn should cause the combined ratio to return to a more reasonable, and profitable level.

Finally, tangible book value came in at $35 million. This in comparison to a market cap of $30 million is enough to hold me in. While I certainly wouldn't commit a large percentage of your portfolio, I will continue to hold my stake. You are at a point with this company where any optimism could push the stock sharply higher while the book value should buttress any negative surprises.

Take Two Interactive's (TTWO) Latest Release is Selling

2006-11-02T21:00:00.000-08:00

Take Two Interactive (TTWO), a company which I was really bullish on a while ago, and still am to a lesser extent, recently released a new video game, Bully. From what I hear the game is violent, and to some, offensive. While there was talk about banning the game somewhere in California, people seem to be ignoring this debate and just buying the thing. In a recent report by UBS, the game ranked as the third best-selling video game last week. This was an increase from 7th spot the week prior.

FYI ... Newer results will be coming out tomorrow.

Altria (MO) Spinoff of Kraft Moving Along

2006-10-30T19:38:00.000-08:00

Conglomerate, Altria (MO), most famous for it's cigarette business, has announced that it is closer to finalizing it's spinoff of Kraft foods. From the article:

Earlier, the New York company announced it plans to finalize its decision, including the precise timing, of its distribution of its 88.6% stake in Kraft at its Jan. 31 board meeting. That announcement came in conjunction with the release of the company's third-quarter results.

Altria faces Massive law suits over it's tobacco business. This has caused the decision to be delayed thus far due to concerns over litigators rights to MO's assets. Of course, the lawsuits should have no bearing on Kraft once separated.

Traditionally you would expect Kraft to be a good spinoff (generating short-term institutional selling and a good buying opportunity) as it is a markedly different business from it's parent company. However, I believe you will see the opposite in this case as MO's lawsuits are likely holding the valuation of the Kraft business down.

One final comment, MO has been cited as 1 of the best-performing long-term stocks ever (over a 46 year time span). This is just another example of how vice can sometimes pay, and one of the reasons I am still holding my Take Two Interactive. If you are interested in the reference, before you click on the link, I warn you that it goes to the Motley Fool. I couldn't find the stat anywhere else. Link here.

BancInsurance Corporation (BCIS) - Pure Value Play

2006-10-25T17:55:00.000-07:00

For a value investor, now is a sad and depressing time. Most companies are at or near 52-week highs and you need to look at next years earnings to get a reasonable PE. Even companies which are in the dog-house still look ugly when viewed over multi-year levels. However, I believe I may have found something worthwhile in the insurance industry.

BancInsurance Corporation (BCIS) is a specialty insurance company, primarily in the property/casualty field. With a market cap of $30 mil it is not for the bigger fish out there. I like that though, I can't help thinking it is keeping the price down.

What is interesting about this company is that it is selling for just under tangible book value (~$32 million) while still earning substantial profit. The valuation is due to a messy expansion into immgration and bail bond reinsurance. It ended poorly in 2004 when the company discontinued the business. The combined ratio got nailed 129% (this means the cost of providing the insurance was 29% higher than the premiums paid), audtiors quit, financial reports were delayed and the company was delisted from the NASDAQ. Subequently investors fled. There is still some overhang from these events as legal proceedings continue. Essentially, 1 company is attempting to recover losses related to the reinsurance from BCIS, while BCIS is attempting to recover losses from 2 other companies. I am not a legal expert but the size & scale of the reinsuracne operations do not seem adequate for the current legal issues to warrant the large-scale selloff that has occurred in the stock.

In spite of these events, the company was profitable in 2005 and quite profitable in 2006. Insurance produces fairly lumpy results due to changes in investment gains but the company will probably come in with a P/E of 5-6 in 2006.

I have to give credit where it's due, this idea was sparked by another investing block, Rational Angle. I recommend if you are still interested in the stock that you check out Rational Angle's post here.

Expectations

The key question is where can the company go and how far? Assuming no more disasters it will probably trend slowly higher. If management writes bad insurance, of course the stock will get hit but you are already buying at book value which will provide some support. Insurance companies don't command the huge book value premiums of other businesses so don't expect any miracles.

If the company can grow modestly (high single-digits), and appreciate to 1.5 times book (slightly below peers), you would be looking at 70-80% over the next 2-3 years. On top of that there is always the chance of relisting on a major exchange, completion of legal proceedings, acquisitions, buyout of the company by another firm, or just enhanced organic growth. Don't fool yourself, it is not a perfect play but I view the risk/reward at this price, as excellent.

Finally, as always, do your own research. This blog, all blogs, in fact all financial analysis, should be used to generate ideas not used as your final source of knowledge on a stock.

Disclaimer

I own shares in BCIS.

Wendy's (WEN) Large-Scale Share Repurchase Program

2006-10-17T20:42:00.000-07:00

Hamburger retailer Wendy's (WED) caught my eye today when they announced that they will attempt to repurchase ~ 19% of outstanding shares in a modified Dutch auction tender. Wendy's closed trading at $34.57, whereas the Dutch auction will occur in the $33-$36 range. I do have to wonder what kind of message their management is trying to send by setting the repurchase range largely below the current price. Perhaps there are some large institutional holders looking to bail? However, ultimately I like the Dutch auction program as it tends to be an equitable and relatively efficient (e.g. cheap) way for the company to distribute it's capital to investors. In this case, assuming the price hasn't been tampered with pre-announcement, it would seem that holders as opposed to tenderers are getting the better deal. In short, if Wendy's was correctly priced based on it's fundamentals then this deal only strengthen's non-tenderers position.

This is not the first major strategic move by Wendy's either. They have recently spun-off their Tim Horton's chain and sold Baja Fresh Mexican Grill. (As a side note, to give you an idea of the popularity of Tim Horton's, there are rumors going around that the company puts cocaine into it's coffee to enhance it's addictiveness.) In addition, the company has announced plans to spend $525 million renovating and repurchasing franchised restaraunts. The company is playing perfectly to shareholder-friendly, refocus -on-the-core principals and investors are rewarding it for it's efforts.

OK, but is it a buy now? Well for that we will need to look at some numbers. The company has revenue of $3.8 billion and 117 million shares outstanding. After the dutch auction, assuming all 19% are repurchased, the company will have ~95 million shares outstanding. This gives a figure of $40 revenue per share. Of course revenue is a meaningless figure in itself, how much profit can they draw from it? Historically not much. Last fiscal year, excluding non-recurring costs, operating income was around 10% of revenue, net income was around 6%. I am not sure if it is a fair comparison but McDonals had operating income of 20% of revenue last year. In fact, McDonald's net income relative to rev. was even higher at 13% than Wendy's operating percentage. Of course, we are not here to talk about Mickey D's, I am just trying to establish that Wendy's certainly has some room to run as far as operational improvements go. This in turn would lead to higher earnings. Another point to note is that even if the share repurchases are financed completed by debt (they won't be, WEN has $1.2 billion in cash compared to $800 million in expected share repurchases) Wendy's will still have less debt relative to revenue than McDonald's. If Wendy's was even able to earn 8% net of revenue, you would be looking at $3.1/share in earnings and a very reasonable share price.

Given their shareholder friendly management, strong financial position (I didn't really cover this in enough detail but take my word for it or look at their latest 10-Q), and potential for operational improvements the company does seem like a good deal. You are not going to get rich off of it, but given the valuations I am seeing on other companies right now it appears an attractive place to park some money.

Disclosure

I intend to buy shares in Wendy's.

Webzen (WZEN) Value Play

2006-10-07T11:40:00.000-07:00

Korean online video game producer Webzen (WZEN) is getting pretty cheap these days and I have decided to bite. The company has produced a number of online games, with flagship MU having been a hit a couple of years ago. Their fortunes have taken a turn for the worse lately but this is over-reflected in the current stock price. The company is currently selling for just over book value, and in spite of this is in no danger of bankruptcy for at least a few years. All it will take is one successful offering and the price will soar.

Financials:

WZEN is an ADR (it primarily trades on the Korean stock exchange) trading on the Nasdaq. It's quarterly financials are not readily available from yahoo or google finance so I went straight to their web-site for the quarter ended, June 2006 numbers. As a side note, in terms of news coverage I would recommend google finance for this particular company, as they have a great deal more coverage. I am not affiliated with either google or yahoo in any way. In general I prefer yahoo finance.

For reference, 1 USD = 949.2 Korean Won according to yahoo finance. I have taken the liberty of converting WZEN's financial statements to US dollars.

Balance Sheet

Current Assets: $114.9 M
Tangible Fixed Assets: $53.6 M

Liabilities: $17.4 M

Tangible Equity: $151.1 M

Income Statement

Revenue: $6.7 M

COGS: $3.0 M
SG&A $15.2 M
Other Expenses: $2.0 M

Net Income (loss): $(15.5) M -- okay, I know this doesn't exactly add up based on the other items but since it is actually LESS than the numbers I added I decided not to fault them.

Summary

Webzen currently has a market cap of ~$171 million dollars. I am pretty sure that is the correct number. It is not so much that I am confused or haven't done my research but there is a lot of conflicting data about something so simple as the companies market cap. Yahoo says it's $47 million, Google says it $476 million, quotes.nasdaq.com says that no in fact it's $14 million. Well I went to the company's website and according to their numbers, the company adds up to ~$171 million US. If I'm wrong feel free to correct me but don't just point to yahoo finance please.

At any rate, assuming my market cap is correct the company is selling for just over book value. Revenue & expenses of course are the real problem. Revenue has been very low recently, below historic norms. SG&A was very high in the last quarter so it looks like the company is bleeding to death. However, even if we were to assume that these results may be repeated (I don't think they will), the company would still have some 2.5 years before it even needs to worry about refinancing. This company will not be going bankrupt anytime soon.

The Situation:

Webzen needs a hit. This is how video game developers make most of their money. It is similar to the movie industry in that a single popular title can far exceed the development costs. However, online-game companies are dissimilar to the movie industry in that their revenue stream from a hit game can go on for years, as the company upgrades it's graphic/software engines, redistributes to new regions, rebrands to cover additional demographics, etc. Basically, if Webzen can deliver a hit or two (we'll get to this momentarily) all past sins will be forgotten and the street will love them again. People start to look at not how quickly it is going to go bankrupt and start focusing on how much money it might earn. That is where P/E expansion comes in and that is the primary reason why I exclusively buy beat-up stocks. 1 or 2 hits and you make a fortune. If the hits don't materialize there is still enough booty in the bank to cover next years attempts.

Of course this entire argument is just wishful thinking if you don't have reason to believe that WZEN might actually produce something. Here is how I look at it:

1) They produced MU in the past which was a big hit and had their stock soaring for awhile. So they are certainly capable of producing a popular game. I have some faith in their management.

2) The company has a slew of games under development. Soul of the Ultimate Nation, Parfait Station, Project Wiki, Huxley, APB (All Points Bulletin). Now I don't really play games anymore so I can't comment on their quality and release schedules but barring some sort of disaster at least 2 or 3 of these games will be released over the next year. Probably the releases will be quicker than that but I like to be pessimistic. I don't know that any will be hits, they could be but I can't make that call. I do know that APB is being created by the developer of GTA (Grand Theft Auto) which was a HUGE hit in it's time and to some extent still is. Given the current valuation I don't feel that the potential for these products to catch on is being fully integrated into the stock price.

3) North Korea has the bomb. Well at least the North Koreans say they do. They certainly have something. Some seismologists thing they have the bomb and some don't. Maybe they have a big pile of TNT. I don't really care. If anything actually happened in this regard, then the reprecussions would extend far beyond South Korea. People don't think that way though, they just get scared. They hedge their bets. As a result, I believe that North Korea's testing has had at least some impact on the stock. On Monday when the initial announcment was made, the stock was down over 8%. I view this, on top of everything else, as a buying opportunity.

4) Webzen is hiring. In spite of all the terrible things people think are going to happen to this company, they just hired 4 new senior types in the US. This brings us to the next point..

5) Webzen is expanding. Previously competing chiefly in Asia, the company is refocused on North America and is talking about Europe. Even the company's vision statement drones up about the importance of gaming for everyone. While games don't exactly port effortlessly from 1 culture to the next, certainly the cost of rebranding a successful game is far less than doing it from scratch.

6) This is a weak point and hard to substantiate but I believe the company's founders are passionate about the company. Just a hunch and I could be wrong. I can't find it anymore but a year ago when I first started looking at WZEN I remember reading a quote from the CEO to the extent that their primary mission was to make great games. Not get rich, not dominate market share, make great games. To me, this is exactly what the company needs to focus on. Think of Google for instance. Why is it so popular? They are the best at what they do. Flat out, everybody knows it, don't even argue with me on this, google is the best at search. When the company was being created that is the only thing the founders tried to do. They didn't even try to incorporate any type of revenue for about 3 years. They just tried to make it better. Did it payoff? Now Webzen is certainly not a Google and maybe they really, truly aren't dedicated to being the very best but as point of reference, at the very least, passion in the founders is a good thing to have.

Disclosure:

I own shares in Webzen. I bought them on Monday. I might buy more.

Do your own research and beware, this could go several different ways.

Private Equity Buyouts

2006-09-27T17:14:00.000-07:00

A good article can be found here which discusses the rates and trends of private equity buyouts of public companies. The article notes that several firms have failed to find buyers over the last month, including Bally Total Fitness:

Jones Apparel Group Inc., Bally Total Fitness Holding Corp., The Pep Boys -- Manny, Moe & Jack and Imclone Systems Inc. all halted their auctions last month after not getting the bids they wanted.

However, in spite of these cases, the aggregate quantity has been increasing:

To date, global M&A volumes have totaled $2.4 billion, up some 34 percent from this time last year, according to industry research firm Dealogic.

In regards to the multiples that buyers are paying:

Valuations for companies with $50 million or more in annual earnings before interest, taxes, depreciation and amortization, or Ebitda, hit 8.6 times Ebitda during the first half of the year, the highest level ever recorded by Standard & Poor's Leveraged Commentary and Data Group.

Western Union (WU) Spinoff & BFT Index Change

2006-09-25T16:57:00.000-07:00

Standard & Poor's announced today that effective Sept 29, Western Union will join the S&P 500. Western Union was spun-off of First Data Corp (FDC) on Sept 21. As a side note, yahoo finance does not seem to list Western Union (WU) yet. Try google finance instead.

In the same release it was announced that Bally Total Fitness (BFT) will be removed from the S&P 600.

Take Two Interactive (TTWO) Delisting Notice

2006-09-21T17:33:00.000-07:00

Video-game developer Take Two Interactive (TTWO) received a delisting notice today from NASDAQ. The notice stems from the filing delay of their third quarter 10-Q. The company claims that it has had to delay filing as a result of an options backdating investigation.

Personally I don't consider this a significant event for long-term holders. The investigation into the options will play a moderate role in it's long-term stock performance but quite frankly I couldn't care less if it's part of an index. In the short-run, of course, you could and probably will see some pain if it's delisted. The fact is though, Dell was handed a similar warning today so I wouldn't be too concerned. If anything, I would consider delisting a long-term buying opportunity and would welcome it as the risk/reward at $14.50 is still a bit steep. Not that the company isn't going to go up, I believe it will, but you just have too much potential downside at $14.50 for it to be a "good" buy. For the record, I got in at $10.61 and am going to wait this out.

Ultimately, I believe the largest factor in this company's long-term performance will be it's profitability. It has not been profitable of late. However, as I pointed out previously, video game developers make essentially all of their profits in the christmas quarter. Last year's christmas quarter was heavily affected by the GTA sex-scandal, again see my past article. This year's christmas quarter is basically a clean slate with a new release of games. The company has delivered hits in the past and will probably do so in the future. Your hedge (well it's gotten a lot smaller at recent prices), is that the company is selling at a fraction of it's past revenues while competitors sell at multiples of 2-5x. Keep it on your radar screen.

Hanes Brand (HBI) Spin Off

2006-09-17T13:29:00.000-07:00

Hanes Brand (HBI) was spun off from Sara Lee Corp. on September 6. The new company produces a variety of undergarments and related items including socks and underwear. It's brands include Hanes, Champion, Playtex, Bali, Just My Size, barely there, and Wonderbra, all relatively well-known and mid-priced.

If we look at Hanes Brand in terms of the desired criteria for a spinoff play, the best I could say is that it partly qualifies as a good spinoff candidate. Ideally what you are looking for is a number of conditions which depress the price but are based on short-term factors. Of course, this is always easier to analyze (and less useful) after the fact.

1) Sara Lee, it's parent company is in the dog-house. The company is currently trading at a level not seen since the early 90's. Some of this reputation may rub off on Hanes Brand. In spite of this, Hanes Brand has strong brand names and an independant management team. For what it's worth, Coach, which was spun-off of Sara Lee in late 2000 has gone up approximately 10 fold.

2) Independant management. This one is a bit tougher and I can't provide too much insight. The current CEO was in charge of the division under Sara Lee as well, so he's not completely independant but you rarely see that in spinoff's. The main thing is that the really senior management (e.g. the CEO) from Sara Lee is staying with Sara Lee and those indvidiuals who have moved to Hanes Brand, are now working for a separate company.

3) Management Incentives - Again this information is not readily available. I do know that some of the senior management held shares in Sara Lee prior to the spinoff. However, given the nature of executive compensation today, it is very likely that senior management has or will receive options.

4) Company differences - One of the theories behind spinoff selling is that institutions are not interested in the business line of the child company. While the clothing segment is certainly different from food products you may actually be seeing the opposite effect here. As a result of it's name brand products the new Hanes Brand could be drawing in new buyers who would have steered clear of the packaged foods and weaker brands of Sara Lee.

5) Index delisting. While Hanes Brand is not a member of the S&P 500 it does belong to the S&P 400 midcap index. As such you are not likely to see the large scale disinterest with a non-indexed equity.

So what we have is a company which does not have sufficient differences or scale to warrant large scale institutional selling. For new buyers that doesn't present a good entry point. The stock has actually been a benefit to Sara Lee shareholders (who purchased prior to the spinoff) as the combined value of SLE & the HBI received in the spinoff is ~$17.75, while Sara Lee was trading for below $17 the day before the spinoff. Essentially, this financial engineering resulted in a short term gain of ~5% to SLE.

So while Hanes Brand did not receive the pummelling I would have liked does it qualify as a buy on it's own merits? Well at this point I would say no. The company DOES have a tremendous debt load of $2.6 billion against operating profits of $400 million. Their debt is junk-rated and hence they face relatively high interest payments. It is not that the company is a sell or even that it won't perform but there is not sufficient margin of safety at this point to bother buying. It is a low growth industry and without knowing more about managements strategy, there seems little reason for optimism.

I will leave you with Hanes Brands' management's opinion on the merits of the spinoff. Link available here.

"Hanesbrands is a large, strong and successful company that is going to get better by benefiting from greater focus as an independent public company," Noll said. "Hanesbrands has tremendous opportunity for growth and improvement through steady and strong cash flow, cost-saving initiatives and investment in powerful brands and product lines. We intend to build our largest and strongest brands, such as Hanes, Champion, Playtex, Bali and others, in core categories through continued innovation of key products."

PIPEs (Private Investments in Public Equity)

2006-09-17T06:03:00.000-07:00

The New York Times published a good and fairly thorough revie w of modern day PIPE transactions, with special emphasis on their abuse by insiders. For those of you new to PIPE's a quick overview:

PIPE's involve the sale of equity to a firm (generally a hedge fund these days) at a price below the current market value. This is performed when companies are in need of capital (often desparately in need) and their financials or the size of the firm makes traditional equity offerings unappealing. The problem of course is that the sale is not handled through traditional markets and average investors do not have access to the deal. This in itself can lead to mispricing and abuse (in my opinion) of common shareholders rights. In addition, during the process of negotiating PIPE's numerous individuals (potential buyers) are made aware of the transaction and are in a position to make short trades as PIPE's generally cause decline in share prices.

From the article:

Over the last 18 months, the Securities and Exchange Commission has filed four lawsuits against individuals and hedge funds that the commission said had profited on nonpublic information about stock offerings.

...

The hot tips at issue in these cases involve an increasingly popular type of security called a “private investment in public equity.”

To be objective we should put these numbers into perspecitve:

According to Sagient Research Systems in San Diego, 2006 is on the way to becoming the biggest year for PIPE’s. As of this month, almost 800 deals worth $18 billion have come to market; in 2005, a total of 1,301 deals worth $20 billion were done.

I am not particularly concerned about the insider transactions as insider trading is in no way isolated to PIPE's. What bothers me, as I said previously, is that certain companies are gaining access to funds at prices negotiated not by the market but by management and the purchaser. Furthermore it seems that at least some of the purchasers have the shortest of time frames in mind:

After the deals close, a company issuing the securities typically files a registration statement with the S.E.C. that will, when approved, let buyers resell their shares in the open market — a process that usually takes about 60 days.

I would be extremely wary anytime a company you are following raises capital through this type of transaction. If the purchase price is at a steep discount, if the company does not desparately need the funds or if there has been any evidence that the deal was leaked (via trading spikes prior to the annoucement), you would be better off investing elsewhere.

As a side note and more rant that practical information, the article also made reference to a web site www.measuredmarkets.com that performs analysis of stock trading patterns. Their goal is to give individual investors information which can be used to predict these types of insider trading activities. So far so good. I looked at the web site and the analysis they have performed, they have indeed shown that they are able to spot the insider trading in some cases. They have not, however, shown that they are able to differentiate betweeen trading pattern changes caused by valid insider trading and those caused by any other type of regular transactions (large institutional buyers). This bothers me and is fairly typical of wall street. Tools are provided, success stories are listed but in the end there is no hard evidence that you can reliably predict what is going to happen. I would love to be proven wrong but I see no alpha here.

UPDATE

I received a reply from an individual involved with measuredmarkets.com after publishing this blog. While I am not going to post his reply, in the interest of accuracy I will just concede 1 point. His site may be able to predict block trades as separate entities from insider trading. Block trades can be a major component of institutional buying but certainly not all institutional buying is done through this type of trade.

Going on Vacation..

2006-08-29T18:48:00.000-07:00

I will be on vacation and won't be updating this blog for the next 2 weeks.

While I'm gone, the Sara Lee (SLE) spinoff of Hanesbrand (HBI) should take place. I believe this is set to occur September 5 or 6. This is not an automatic buy simply because it is a spinoff. There should be some financials released when it is spun-off providing better insight into it's debt structure, revenue, earnings and compensation of key executives. Make sure you look into these numbers prior to making your decision.

For those who care about such things, Cendant has announced a reverse 10 for 1 stock split and a new ticker symbol CAR. The theory behind the reverse split is that it will provide credibility to the company simply through a higher share price. I assume that the name change was partly to erase the Cendant legacy from the company. For analytical investors these should be treated as non-events.

Bally Total Fitness (BFT) -- Hedge Fund Activism

2006-08-25T18:00:00.000-07:00

Bally Total Fitness (BFT) has entered a confidentiality agreement with Hedge fund Pardus Capital Management. According to the article:

Pardus said in a filing with the Securities and Exchange Commission on Thursday that Bally will give Pardus "certain nonpublic information about the company for the purpose of evaluating and negotiating a possible strategic transaction with the company."

Under the terms of the agreement, Pardus can nominate individuals for election to Bally's board of directors; bring business before a stockholders meeting; and conduct a proxy solicitation in support of director nominees, according to the filing.

This is just another chapter in a long battle to repair the heavily indebted company. A brief timeline of events follows:

August 24, James F. McAnally resigns after 10 years.

August 11 - the CEO resigns. Don Kornstein is appointed interim Chairman, Barry Elson is appointed as acting CEO. Side note, Don Korstein apparently worked in the investment banking department of Bear Stearns. Pardus and Liberation Investments is in support of the new management. While independant, Pardus and Liberation own approximately 25% of outstanding shares and have a vested interest in cooperating and driving change in the company.
- the company announces that plans for a sale or merger have fallen through
- operating income is forecast to drop by 10-20% year over year
- filing of the quarterly report is postponed

March 21 - The company received a temporary lift when it was announced that Richard Branson's Virgin Group was interested in acquiring the company. It is now known that this deal fell through.

September 2005 - The company announced that it would sell it's Crunch Fitness Club to help pay down debt. This sale eventually went through.

Outlook

Bally Total Fitness is faced with interest payments which generally exceed operating income. On top of this, operating income has begun to decline. Without large scale operational changes or capital restructuring the company faces bankruptcy.

However, with control shifting to the hedge funds, these types of changes are exactly what is in store. In the latest press release, Pardus has indicated that they are interested in strategic alternatives. On August 11th, Liberation increased their stake in the company and had this to say about their intentions:

It also wants to arrange or participate in talks with third parties about a potential purchase of Bally's assets, a reorganization or investment, according to the SEC filing.

Liberation also said it may hold talks with Bally stockholders, management or board to maximize the value of their investment. The moves could include the purchase of additional stock, the sale of its stake or private deals to transfer its shares to another group.

Valuation

BTF is cheap. It is also near bankruptcy. A few comparison numbers with competitor Life Time Fitness (LTM) illustrate the point (all numbers 12 months ending March 31/06):

BTF

P/E: Effectively negative, the company realized a small gain after selling assets but is losing money each quarter.

P/Operating Income: 1.49

P/Sales: ~0.1

P/Tangible Book: -.07 This is better understood in absolute values, a market cap of $106.8 million over -$1.46 billlion tangible assets. However, much of this is Deferred Long Term Liability Charges. The company had $713 million in long-term liabilities, March 31.

LTM

P/E : 34.5

P/Operating Income: 18.3

P/Sales: 3.7

P/Tangible Book: 4.8

Conclusion

While I am not quite ready to pull the trigger, at present price the risk/reward ratio seems appealing. Any sort of improvement could lead to a large rally. Consider that the company is currently trading at $2.58, and has ranged from $2.33-$9.92 over the past 52 weeks. It is also worth noting that the market has reacted very mildly to the latest news of Pardus investigating strategic alternatives. Investors seem to have lost faith. That is usually a good time to buy.

Private Equity IPO's

2006-08-24T08:57:00.000-07:00

Are private equity IPO's special situations? Business week ran an article a few weeks ago on them. From the article:

The question is: Will the Hertz deal be good for public investors? If other recent IPOs are any indication, the answer is a resounding no. On average, the stocks of companies taken public by buyout firms this year have fallen 6%. In contrast, shares of companies that have gone public without any assistance from buyout firms have risen 0.7%.

Okay, fine, so they are not good investments this year, why investors even care about such short-term performance is beyond me. What I want to know is whether they are superior long-term investments. If I have to wait a few years that is fine. The article has this to say on long-term performance:

Soon-to-be-released research by professor Josh Lerner at the Harvard Business School will show that in the last two decades, companies taken public by buyout firms have outperformed other IPOs and the major market indexes. That's because buyout firms usually take three to 10 years to carry out the sort of operational improvements that could justify their huge payouts in IPOs.

Now I am not saying that all private equity IPO's are buys, many are over-burdened with debt and I would only purchase them on deep discounts. Then again as they lose credibility in the mainstream press you are more likely to see these discounts.

Weyerhaeuser (WY) to spinoff/split divisions to Domtar (DTC)

2006-08-23T18:50:00.000-07:00

Forestry conglomerate Weyerhaeuser announced today that it is planning to spinoff or split-off it's fine paper division and merge the division with Domtar (DTC). A few points from the article cover pretty much all there is available right now:

The new company is expected to be the largest fine-paper company in North America.

...But as more and more documents -- such as legal rulings and financial reports -- have gone electronic, analyst Paul Latta with McAdams Wright Ragen said many have begun to think of it as a sector in decline.

...Weyerhaeuser shareholders will get a 55 percent stake in the new company and Weyerhaeuser will nominate a majority of its 13-member board

The companies said the deal is expected to generate about $200 million in annual "synergies" -- cost savings and extra revenue -- within the next two years, because the combined operation will be able to save money on things like transportation, logistics and purchasing.

Under the agreement, Weyerhaeuser will receive a $1.35 billion cash payment.

The deal has been approved by both companies' boards, and is expected to close early next year.

Another article has this to add:

Excluding overhead associated with the fine-paper business, Weyerhaeuser's operating earnings per share would have been $2.13 in the first quarter vs. the $1.78 actually reported, Rogel said.

This has the potential to be a good special situation. The stock will likely have a high debt load after the $1.35 billion special dividend, it is currently unprofitable and it is in a hated industry. Of course this is only appealing if it leads to large scale selling. It seems that the potential for economy of scale also exists. We will have to wait until more details emerge for a more conclusive analysis.

Gateway (GTW) Receives Offer for Retail Division

2006-08-23T17:24:00.000-07:00

Computer hardware retailer Gateway (GTW) received a $450 million offer from a private investor for it's retail operations today. From the article:

The founder of eMachines Inc. has offered $450 million to acquire the retail business of Gateway Inc., in a bid that intensified speculation about a possible buyout of the long-struggling PC maker.

To put this into perspective, Gateway ended today with a market cap of $725 million and according to the article:

Gateway's retail operations accounted for $592 million, or 64 percent, of its revenue of $919 million in the second quarter.

Gateway was removed from the S&P500 on July 25, an event which can lead to price discrepancies as institutional investors sell.

So is gateway now a buy? Well let's break the numbers down. Gateway has a $450 million purchase offer for it's retail business divided by a market cap of $725 million. That gives a ratio of .62 or 62%. The retail operations acount for 64 percent of revenue so based purely on sales the company is just fairly valued assuming that the sale goes through.

Realistically, we should also look at earnings as it is possible this is an under-performing division. For that you need to look at the quarterly or annual reports, the quartely reports are accessible here.

The following numbers are from the 2nd quarter, 2006 report.

Retail - This is the unit on which the purchase offer was made

Sales : $592 million, a 21% year over year increase.
Segment Contribution : $17.2 million

Professional

Sales : $250 million, an 8% year over year decrease.
Segment Contribution : -$8.3 million

Direct Sales

Sales : $77 million, a 31% year over year decrease.
Segment Contribution : $9.3. million

So if you sum the segment contributions from the remaining 2 divisions you get $1 million. These numbers can swing either way quarter over quarter but I have a hard time believing that the remaining divisions are worth more than their relative proportion of revenues.

Although Gateway qualifies a a special situation due to it's delisting and potential purchase, it seems that at present it is fairly valued. I don't feel comfortable paying fair value. The computer hardware industry is very tough right now with even ultra-efficient Dell (dell) posting large earnings declines. It seems that this is a business where scale matters and Gateway, with $3.6 Billion in annual sales just doesn't stack up to Dell's $55 Billion. This is not to say that Gateway can't make it or that Hui won't purchase the whole company but at current prices I would prefer to remain on the sidelines.

Cendant (CD) Completes Travelport Sale

2006-08-23T17:14:00.000-07:00

Cendant has completed the sale of Travelport for $4.3 Billion today. They announced this previously so I consider the sale itself a non-event. Cendant is planning to distribute $1.4 Billion of the proceeds to recently spun-off Realogy, $760 million to Wyndham and use the remainder to pay expenses and debt.

More interesting, Realogy announced that they will be using the majority of the funds to repurchase 19% of shares outstanding (48 million shares or $970 million worth at todays closing price of $20.23). The remaining funds will be used to repay debt. Realogy also lowered earnings expectations to $250-340 million in fiscal 2006 ($1.03 - $1.43 per share). The company still doesn't seem like a buy to me given the state of US real estate but the share buybacks are encouraging.

Other links on Cendant and the Wydham/Realogy spinoffs are available here, here and here.

Bausch & Lomb (BOL) Study Finds Recall Necessary

2006-08-22T17:59:00.000-07:00

Preliminary findings on the Bausch & Lomb (BOL) contact lens recalls have been released. From the article:

Bausch & Lomb Inc.'s global recall of a popular contact lens solution in May appears to have stopped the spread of a serious eye infection but U.S. scientists still do not know what caused the outbreak, according to a study released on Tuesday.

The article also had some interesting statistics on the infection:

As of June 30, the researchers had identified 164 confirmed cases of the fungal infection fusarium keratitis. Of those, 94 percent, or 154 patients, wore soft contact lenses. Infected patients came from 33 states and one U.S. territory and about 34 percent of them required a corneal transplant.

According to the study, infected contact lens wearers were 20 times more likely to have used Bausch & Lomb's ReNu with MoistureLoc lens solution than another solution.

In terms of financial costs (for reference BOL has a market cap of $2.6 Billion):

In addition to the loss of a $100 million-a-year product, analysts have estimated Bausch & Lomb faces $500 million to $1 billion in potential liability from the infection.

Bausch & Lomb responded to the article shortly thereafter:

We think the report confirms that Bausch & Lomb took the right action in the interests of consumer health and safety by recalling the MoistureLoc product, and that Bausch & Lomb can continue to recommend its ReNu^® MultiPlus^® solution with confidence.

BOL's stock price has been hit hard as a result of the contact lens recall. In spite of this, there does not appear to be sufficient margin of safety in BOL to warrant investment. The company sells for ~5x tangible book value, 16x earnings (before the recalls) and ~1.2 x sales.

Previous post on BOL are available here and here.

Pep Boys (PBY) Takes Itself Off the Market

2006-08-17T08:59:00.000-07:00

In a recent report Pep Boys (PBY) has declared that it is taking itself off of the market. From the article:

The Philadelphia-based automotive parts and service chain also disclosed that in its search for a buyer or pursuit of strategic alternatives, it didn't find anyone interested in acquiring the entire business. Late Tuesday, Pep Boys said it was taking itself off the market and will focus on improving the business.

I mention this mainly as a word of warning about the potential sale of Cendant. To summarize that article, Cendant announced that it will consider selling itself (it is now a car rental company) to private investors. Despite the boom in private equity investment, buyers and sellers do not always agree on a suitable price and poorly performing businesses can be as unattractive to private investors as the general equity markets.

For value/turn-around investors, Pep Boys may be worth a look as it is selling right around tangible book value, near a 52-week low and is still eaking out a small profit.

Triple Crown Media (TCMI) Post Spinoff Analysis

2006-08-16T16:01:00.000-07:00

In a somewhat complicated transaction, TCMI separated from it's parent company Gray Television, last december, and shortly thereafter merged with Bull Run corporation. The company operates a disparate collection of businesses: newspapers, collegiate marketing, collegiate production services, a management services company and a wireless provider. I really don't do it justice but there is a fairly exhaustive summary here for those interested.

Usually the pupose of a spinoff is to allow the parent or the child company to receive a "purer" valuation (that means higher) due to the simplicity of valuation. In this case, only Gray Television would have received the benefit. Personally, I don't consider this an issue, this company is still less complicated than say GE, which still garners a very healthy valuation.

TCMI is interesting from a special situations perspective for a number of reasons:

1) It has a massive debt load for it's size. To put it into numbers, at current prices, TCMI has a market cap of $38 million, and long-term debt of $118 million. In total, TCMI, as of March 30, listed $168 Million in assets and $158 million in liabilities. Much of the assets are in the form of goodwill or intangibles. As such, the company has tangible assets of $-93 million. So the company is highly leveraged but this is counterbalanced by a very depressed stock price. Obviously not something you want to sink your whole portfolio into but that same reaction is probably keeping many fund managers away.

2) TCMI is small. Again, it has a market cap of $38 million. Most mutual funds cannot gain a meaningful piece of it, I doubt most would even look at it.

3) The whole TCMI situation is somewhat complicated. Long-term financials are not readily available, it was a complicated spinoff and their are several different types of businesses bundled as TCMI.

4) The company has incredible price appreciation potential. In the last quarterly results, the company listed $34 million in revenue ($136 million annualized) and $4.6 million operating income ($18.4 million annualized). To put this into perspective, Gannet Company, a large newspaper publisher and admittedly not a perfect comparison, is doing about $8 billion in revenue per year and has a market cap of $13 billion. To be fair though, Gannet does make a healthy profit.

5) The shares were originally tendered at ~$15 / share last December. Currently the company is sitting around $7.50. Management clearly thinks higher of the company than the market does.

6) Management has considerable interests in stock price appreciation. In a series of SEC filings on April 27, 3 senior executives received rights to large stock option blocks:

Cornwell Steven, Exec. VP Operations, 20000 shares, expire 2016, exercisable at $5.43 / share
Meikle Mark, Exec. V.P. & CFO, 25000 shares, exercisable at $5.43 / share
Tom Stultz, CEO, 100000 shares, expire 2016, exercisable at $5.43 / share

Company Outlook

This is all fairly meaningless of course, if the company does not survive. There is tremendous risk with the high debt the company carries. There appears to be little synergies between the businesses it manages (that is more speculation on my part than analysis). In spite of this, I think TCMI will survive. My reasons include the following:

1) In spite of it's huge debt load, despite recently merging Bull Run, and despite just recently spinning off as an independant company, Bull Run made a small profit of $464K in the quarter ended March 31, 2006. If you disclude amortization of intangibles (this is a paper expense only), they profit would have been closer to $1 million.

2) I anticipate that the company will be able to cut costs over the next couple years as recently merged companies tend to have at least some overlap.

3) I am repeating myself, but management has a strong interest in the company NOT going under.

Do your own research, and it would be very helpful if I could get some comments on the idea.

Cendant (CD) and Take Two Interactive (TTWO) - Carl Icahn reveals ownership

2006-08-15T12:05:00.000-07:00

In a recent report (this version of the analysis is more readable) it has come to light that Carl Icahn has ownership in Cendant and Take Two Interactive. The filing was current as of June 31.

If he held his position, he would now have ownership of Cendant, Wyndham and Realogy as a result of the spinoff. He is listed as having 6.1 million shares of Cendant out of some 1 billion shares outstanding. As such he has little direct control over management. It seems likely that he picked Cendant more because current management shares his style of extracting value from troubled businesses.

His stake in TTWO is again likely meaningless as far as influence over management. He owns 800,000 shares out of ~72.5 million shares giving little influence other than psychological. I remember reading, but cannot find the post, something about him financing a video game startup so perhaps this has given him some insight into the software company.

More on Take Two Interactive here and Cendant here and here.

HealthSouth (HLSH.OB) Potential Spinoff

2006-08-14T11:10:00.000-07:00

HealthSouth has announced plans to divest it's surgery and outpatient rehab centers. The outpatient division is quite small in comparison to the parent, from the article:

In the three-month period ended June 30, HealthSouth said that among its four primary operating divisions, surgery accounted for 24.5% of revenue and 18.1% of operating earnings; its outpatient division contributed 11% of revenue and 6.8 % of operating earnings

Another article provides comments on the form that the divestiture might take:

Chief executive Jay Grinney said HealthSouth is considered alternatives including a spinoff or sale of its underperforming divisions.

The company has clearly stated that they will use the proceeds to pay off debt. In the case of a spinoff this would likely mean the spun-off division would take on a large debt load and pay it back to the company in the form of a tax-free dividend. High-debt can exacerbate institutional selling in the case of a spinoff. On the flip-side, HealthSouth is relatively small at $1.8 Billion and is not part of the S&P 500 which will limit the amount of selling when and if a spinoff occurs. In spite of this, the story is worth watching.

Tyco (TYC) Share Repurchases

2006-08-13T14:37:00.000-07:00

Tyco released it's third quarter results last week. To summarize the financial numbers, revenue was up 5.1%, and net income fell from $.56 per share to $.42 per share of which 6 cents was attributed to 1-time charges. Tyco is made up of four divisions, all but the fire and security division saw operating income decreases despite generally posting higher revenue. Overall I thought that the numbers were somewhat concerning given their trend but their is too little data at this point to make a case that the company is in long-term decline. However the valuation still seems reasonable at ~$25.50 per share, and an estimated forward P/E of 12.38.

The company is undertaking large scale share buybacks as seen in their 10-Q. During the past 9 months Tyco has repurchased 71 million shares for $1.9 Billion, or about 3.5% of outstanding shares. They also state in the report their intention to continue to repurchase shares and have $1.3 Billion remaining in their current share repurchase program. In spite of the capital allocated for share repurchases, Net Tangible Assets have increased by $1.9 billion over the past 9 months.

I originally posted about the Tyco (TYC) split up here.

Take Two Interactive (TTWO) update

2006-08-13T14:18:00.000-07:00

The July video game sales numbers just came out and they are fairly encouraging. Aggregate industry sales are up 22%. Take Two Interactive (TTWO) saw even larger gains as described in the article:

Meanwhile, Take-Two Interactive Software Inc.'s shares dropped 2 cents to $10.62 on the Nasdaq. The company saw sales rise 34 percent, helped by easy year-ago comparisons and gained one percentage point of market share to 8 percent.

Note the casual reference to the market share increase of 1%. When you break it down, going from 7% to 8%, this translates into a 14% gain in market share.

I wrote a post earlier this week on TTWO as a value play, it is accessible here.

Advanced Data Processing (ADP) spinoff

2006-08-10T17:15:00.000-07:00

Advanced Data Processing (ADP) announced it's intention last week to spin off it's Brokerage Services and Securities Clearing companies into an independant company. It is aiming to finalize the spinoff by the end of fiscal 2007 (June 2007). According to the Motley Fool, the Brokerage Segment represent about 20% of revenue. Unfortunately the new entity will not be small enough to warrant large scale institutional selling but it is worth keeping an eye on what the new management will look like, how much skin they have in the game (shares & options) and how tightly coupled it will be to ADP.

It seems the primary motivation for the spinoff may be it's low growth relative to the rest of ADP, as described in the Red Herring:

The company has typically only seen single-digit growth in the brokerage services business and is aiming for double-digit growth in its payroll-processing and back-office businesses.

The article also describes the standard spinoff motivation of a simplifying analyisis of the parent company. This often leads to a higher price.

Mark Marcon and Jeffrey Meuler, analysts with Robert W. Baird & Co., view the spin-off as a positive move for ADP. “The unit has been a drag on ADP’s margin improvement and we believe that the concerns regarding secular trends in the division have held back ADP’s multiple,” they wrote in a research note.

Cendant (CD) Up for Sale?

2006-08-10T17:09:00.000-07:00

Cendant announced today in a conference call that it will consider selling itself, or either of it's 2
recently spun-off companies, Realogy (H) and Wyndham (WYN), if the right price came their way. This should come as no surprise, Cendant is in the process of finalizing it's sale of it's Travelport business to private investors.

For general information on the Cendant spin-off click here and here.

What makes the company interesting from a special situations perspective is that the company's executives have substantial equity interests in the various Cendant
entities. For instance, the CEO is listed as owning 9.3 million shares pre-spinoff (at current prices, the 3 divisions are worth about ~$12.50 a share, which puts his piece of the pie at $116 million) and seem intent on maximizing their value through whatever means available. While I applaud the approach, their numbers would make me question the inherent quality of the
underlying businesses. Just be aware that if a sale does not go through it could take
some time to realize the underlying value discount and results could deteriorate while you are waiting.

Cendant closed down at $1.89 on the news.

Sara Lee (SLE) Spinoff

2006-08-09T16:48:00.000-07:00

Sara Lee will be spinning off it's Hanes brand company in September. This is part of a long-term restructuring effort at Sara, as they have spun-off or sold a number of companies over the past few years including Coach.

Hanes, with $4.7 billion in sales, will be taking on $2.6 billion in debt when it is spun off. The unit had earnings of $263 million in the past 39 weeks.

Cendant (CD) Spinoff

2006-08-09T16:23:00.000-07:00

Cendant completed the spinoffs of it's real estate division (Realogy R) and hospitality division (Wyndhan WYN) about a week ago. It has also announced the sale of it's Travelport business for $4.3 Billion has received antitrust approval.

Post spin-off analysis:

CD was originally selling for $15-19 billion in the 52 weeks pre-spinoff. Currently, the sum of the parts goes for about $12.30 billion, divided as follows:

CD - ~1 billion shares * $1.99 = $1.91 billion

WYN - 200 million shares * $26.07 = $5.21 billion

H - 250 million shares * $20.72 = $5.18 billion

= $12.3 billion

For spinoff junkies this might be worth looking at.

Cendant also announced it's latest and final quartely results with all divisions included. From this point onwards, "Cendant" is really Avis/Budget rent-a-car. The results were less than expected, revenue up 2% and EPS from continuing operations of $.17 or $170 million including restructuring costs.

Now I am not advocating Cendant but you might want to keep an eye on it. In it's new form (as a car rental company) it is selling for $1.99 billion with expected revenue of $5.6 billion. Earnings are likely to be weak as EBITDA is predicted to be $260-295 million. Digging through some statements it looks like actual earnings will be less than $100 million for a steep P/E of 19+. However there are restructuring results included in those numbers and they are getting hit hard by the increase in interest rates. Consider that Dollar Thrifty (DTG) has revenue of ~$1.55 billion and a market cap of $1.02 billion for a P/S of .66 compared to Cendants P/S of .34. There is similar debt levels between the 2 companies.

Take Two Interactive value play (TTWO)

2006-08-09T15:01:00.000-07:00

Take Two Interactive (TTWO)

Take Two Interactive is a developer of software games for personal computers, video game consoles, and handheld platforms. I am not writing to tout the growth prospects of the video game industry so mach as to show an excellent turn-around situation. So let's quickly move on to the dirt.

Negatives:

1)
Grand Theft Auto, TTWO's most successful product, was pulled off shelves last year due to a scene containing sexual materials. However, the company is still selling modified version of the product with a different adivsory rating. This years sales are going to be impacted adversely. Nevertheless, this is not a significant long-term event. The advisory rating on this version does not dictate the advisory rating on future releases nor does it impact other products by the company. Also, the target audiences do not look at this in a negative light, perhaps the opposite. This situation reminds me of criticism over Abercombie and Fitch's racy catalogues several years ago. The stock has soared since then.

2)
Perhaps more significant is a options backdating investigation by the SEC. However, the company is under investigation for options backdating in 2003. While this is certainly a concern, there is a new CEO (albeit the president at the time of the scandal) installed in 2005. I view this as a serious issue, the present management cannot fully be trusted, and the stock price should reflect it. Having said that, this is hardly the only instance of options backdating and the stock is oversold on the news. Consider that the SEC is investigating 80 companies for improprieties in backdating options. This includes 2 of Take Two's competitors, THQ & Activision, both of which trade at substantial premiums to TTWO and to both of which I would apply the same comments about upper management. This is business, companies bend the rules, what is important is that you as an investor are sufficiently compensated in the form of a reasonable stock price for these unknowns. In TTWO's case, you are more than sufficiently compensated.

3) In general, the video game industry has not been very hot in 2006. Industry sales were down through the early part of this year

Positives:

1) In spite of everything, the last version of Grand Theft Auto was the best selling video game of 2006. There have been multiple versions of it released and, as media companies have done with successful movies, TTWO can continue to generate revenue by releasing tangential and enhanced versions of the product. In fact, this would appear easier to do in the video game industry as upgrades to hardware render older games obsolete motivating consumers to purchase the "new" version.

2) TTWO has numerous other software programs, including rights to the Civilization series, which was HUGE in the 90's and could certainly be exploited further.

3) Video game sales may already be turning with industry-wide sales in July up 25%.

4) I said I wasn't writing to tout the video game industry but even without any significant growth this stock has upside potential. A boom in the video game industry would just be gravy: Next generation Nintendo and Sony consoles are expected to be launched in fall, while the XBOX 360 has already came out. The new sony console is notable in that it contains 8 processors (as opposed to 1 for the previous console) and is considered to be years ahead in it's graphics capabilities. This is the first large scale console release since 2002. Many industry analysts expect an upturn in sales due to the excitement generated by the devices as well as the luring of larger demographic segments. As well, the new devices include internet connectivity which provides new revenue streams, such as online gaming and advertising, for the game providers.

Valuation:

In recent quarters TTWO has seen a slowdown in revenue and a drop in earnings. Due to the problems with Grand Theft Auto, the critical christmas quarter was much weaker than in the past and TTWO suffered a lost this past christmas. It should be noted that many video game publishers make the majority of their profits in the fourth quarter. As such TTWO does not seem cheap based on past 12 months earnings and I would rather focus on future earnings and past revenue numbers for this company and their competitors. All of the following companies are video game developers and while they appeal to different niches a general comparison should be appropriate:

For an apples to apples comparison I am including both the Fiscal 2005 revenue (to show what the stock had done in the past when thing went ok) and the past 12 months from April (for a better comparison with it's rivals)

TTWO Revenue 2005 (Ending Oct 31/05) - $1.2 Billion
Revenue 2005 (Ending Apr 30/06) - $1.0 Billion
Market Cap $770 million
P/S (Oct 31/05) 0.64
P/S (Apr 30/06) 0.77

ERTS Revenue 2005 (Ending Mar 31/06) - $2.95 Billion
Market Cap $15.22 Billion
P/S 5.15

ATVI Revenue 2005 (Ending Mar 31/06) - $1.47 Billion
Market Cap $3.56 Billion
P/S 2.42

THQI Revenue 2005 (Ending Mar 31/06) - $.86 Billion
Market Cap $1.6 Billion
P/S 1.86

Earnings for the year ending Oct 06 are expected to come in at -.67 per share or $-48.7million. However, I will note again that the majority of earnings are generated in the christmas quarter ending January.

This year is going to be a write off but with net tangible assets of $375 million, this company can afford to soldier on while it gets it's problems behind it.

Factors that Could lead to price improvement

1) Significant management change

2) Buyout by rival firm

3) Improvements in video game sector as new consoles are deployed

4) Market memory of these incidents, especially sex scandal, will fade over time if not repeated

5) New range of products should lead to improvements in revenue and return to profitability

(WB & GDW) Wachovia to Buy Golden West Financial

2006-05-09T18:17:00.000-07:00

Wachovia has announced a deal to buy savings & loan giant, Golden West Financial. The deal values GDW at 1.051 shares of WB and $18.65 in cash. WB has dropped from ~$59 to the high $54s as a result of the deal.

The main criticism of the deal is that WB may be buying GDW at the peak of the real-estate market. However, WB has been around for over 40 years and has weather past real-estate storms.

Since the announcement, WB has dropped over $7 billion in market cap, while the premium for golden west amounts to only $4 billion. In addition the premium is substantially less after taking into account the WB price drop. As such, perhaps the market is over-reacting and we are seeing some large-scale institutional selling.

(BOL) Bausch & Lomb Rating Cut by S&P 500

2006-05-04T17:07:00.000-07:00

The S&P 500 has dropped it's rating on Bausch & Lomb down. They cite potential litigation and brand impairement. BOL is now trading at ~$41, down from a 52-week high of ~$87 .

(EK) Eastman Kodak Plans Sale of Health-Imaging Business

2006-05-04T16:48:00.000-07:00

From the article:

Created a year after the discovery of X-ray film in 1895, the unit accounts for nearly one-fifth of Kodak's overall sales but its operating profit plunged 21 percent last year as margins tightened. A sale would wipe out most or all of Kodak's $2.6 billion in debt, analysts noted."

"...Shannon Cross of Cross Research in Short Hills, N.J, the business might fetch $1.5 billion to $2 billion"

"...Buckman, Buckman & Reid in New York who thinks the unit "can bring at least $4 billion.""

"...Kodak lost the equivalent of $1.04 a share in the January-March quarter"

Not a pretty picture, but it could be an opportunity. Legendary Bill Miller is banking on the stock making a recovery. For those who don't know, Bill Miller he has beaten the S&P 500 for 15 years straight. His picks include Dell and AOL (back when it was going up).

Some general background on the Eastman Kodak situation.

(BOL) Bausch & Lomb knew of lens solution problems in advance

2006-04-27T08:51:00.000-07:00

In a recent news article, BOL has admitted that months before the lens solution scandal broke, it knew about potential problems. From the article:

"Bausch stock price fell 3.5 percent after The Wall Street Journal reported Thursday that Hong Kong authorities had told the Rochester, N.Y.-based company about eye infections among users of its contact solution in November, 2005. But the company only stopped selling ReNu with MoistureLoc, the product in question, on April 13, 2006. A Bausch spokeswoman acknowledged to CNNMoney.com that the report was accurate."

(F) Ford Motor Co. Bankrupcty Play

2006-04-14T13:25:00.000-07:00

You can't have a special situation blog without talking about American auto manufacturers, so I thought I'd start with Ford.

Crippling pension & medical obligations, defiant unions, foreign competition, and perhaps just inferior cars have been driving Ford (and GM) stocks down over the past couple of years. However, Ford has started a major restructuring which includes: lowering manufacturing capacity, reducing the workforce and renegotiating health-care costs.

In this time of inflated executive compensation, Ford CEO Bill Ford brought in 40% last year than the previous. This number might be dropping even more:

"Bill Ford said last May that he would take no salary, bonus or other awards until the automaker's automotive operations return to profitability. But he did receive nearly $5 million in restricted stock equivalents under an incentive plan established before he made that commitment. Ford plans to donate that amount to charity, the company said."

(BOL) Bausch & Lomb Plummets on Federal Investigation

2006-04-13T11:59:00.000-07:00

1:55 PM April 14,2006

Bausch & Lomb has issued a general recall on the ReNu with MoistureLoc (lens solution) product. At the same time, the company has indicated they are committed to fixing the products and just seem to want to get this behind them. To put things into perspective:

"MoistureLoc hit stores in late 2004 and generated $45 million in U.S. sales last year -- a small portion of Bausch & Lomb's more than $2 billion in annual revenues. The company also makes contact lenses, ophthalmic drugs and vision-correction surgical instruments."

12:30 PM April 13,2006
Bausch & Lomb is currently being investigated to see if a batch of it's len solution may cause fungal infections in users. It is currently under pressure to issue a large scale recall of it's contact lens solution and in fact many retailers have begun to pull the lens solution off their shelves. In additon the company has delayed filing it's 10-K. As a result it's stock price has plummetted by ~1/3.

In recent news, Sears has announced that they are pulling BOL's products from it's shelves.

(FDC) First Data Corp. Spinoff

2006-04-12T11:52:00.000-07:00

First Data Corp. is planning to spinoff payment processor Western Union, to existing shareholders. Western Union accounted for $4 billion in revenues last year, out of FDC's $10.5 Billion total revenue. The spinoff is expected to complete in second-half 2006.

Interestingly, FDC shares shot up 7% on the day the spinoff was announced, despite simultaneously reporting a 14% drop in earnings.

(TYC) Tyco Split-Up

2006-04-08T08:35:00.000-07:00

2:02 PM April 14,2006

An opinion piece on the Tyco split-up with mixed signals.

April 10,2006
Tyco announced last January that they are going to split the conglomerate into 3 independant entities. The breakup will probably occur early 2007. Analyst opinions on the potential value unlocked is mildly optimistic at best. However, it seems that part of the indifference stems from recent weakness in core business results. Specifically:

"net income fell to $570 million, or 28 cents a share, compared with $730 million, or 34 cents a share, in the year-earlier period. Adjusting for a $237 million after-tax loss from the sale of its Plastics, Adhesives and Ludlow Coated Products businesses, income came to 39 cents a share.

Analysts polled by Thomson First Call forecast earnings, on average, of 38 cents a share."

In the latest news, Tyco has announced that it's electronics division, will be relocating it's headquarters to the Philadelphia area.

General - Spinoff Results

2006-04-07T18:45:00.000-07:00

Fortune has a follow-up article on the performance of some recent spinoffs. These turned out to be some good picks, perhaps due to the specialized nature of the new companies. On average the 4 stocks have returned 50% since March 2005.

The article also lists some up and coming spin-offs: Tyco (TYC), Acco Brands (ABD), Cendant (CD) and Wendy's (WED).

Also, of note was another analysis piece on the historical performance of spin-offs (future results may not reflect past performance ...):

"Lehman Brothers strategist Chip Dickson recently studied 88 spinoffs done between 2000 and 2005 and found that they beat the S&P 500 by a staggering 45 percentage points on average in their first two years as independent companies."

General - Spinoff Analysis

2006-04-07T11:16:00.000-07:00

BusinessWeek had an interesting article on recent and proposed spin-offs with some analysis as to why they tend to product above-average results:

"Why do spin-offs tend to outperform? In S&P's view, their shares tend be inexpensive initially because investors often sell when they receive stock in a new company they did not intend to own. Also, spin-offs are dumped by index funds when the new company is not in the original index, and institutional fund managers sell shares as a result of a spin-off's lack of liquidity or dividend."

(CD) Cendant Split-up

2006-04-06T21:21:00.000-07:00

Cendant, the travel and real estate conglomerate, is planning to split into 4 separate, more stream-lined (purportedly) companies throughout the year. It's current holdings include Orbitz, Century 21, and Avis.

In the latest news, Cendant has filed to spin off it's real estate division, Realogy in June. The new company will include Century 21, Coldwell Banker and Sotheby's International Realty..

The real estate division accounted for approx. 40% of 2005 revenue.

The company also announced that next in line, will be the separation/creation of a hospitality /time share business. The hospitality business accounted for approx. 8% of 2005 revenue, while time share made up 10%.

(KFT) Kraft Potential Spinoff

2006-04-06T18:55:00.000-07:00

Looks like Kraft might be a potential spin-off (85% owned by Phillip Morris (MO). A date has not been set yet, as they are still waiting to clear some lawsuits. To quote from Reuters:

"The "lights" case has been closely watched not just because of the size of the ruling, but because it is one of the legal hurdles management has said need to be cleared before it could spin off Altria's Kraft Foods Inc. (NYSE:KFT - News) business from its tobacco businesses."

What really drew my attention to Kraft, was this bit on a post-spinoff sellof, from Buisness Week:

" But some analysts wonder if the market will welcome another helping of Kraft, whose margins have been shredded of late. Shares are down 12% from their 52-week high and trade 4% below the IPO price. If Altria shareholders decide they don't want Kraft, the subsequent sell-off would put more pressure on an already struggling stock.

Complicating matters, Altria's now 87% stake in Kraft is worth $43.5 billion. The value of large-cap food stocks in the hands of public investors is roughly $100 billion. So post-spin, Kraft would account for one-third of the industry, a huge hunk of cheese for the market to digest."

Not a perfect stock by any means but nevertheless, large-scale selling may create a bargain.