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Archive for July, 2010

Nelson Peltz’s Trian Fund Management has disclosed a 6.6% stake in Family Dollar Stores Inc (NYSE:FDO). The Purpose of Transaction item on the 13D discloses fairly standard boilerplate, although a buyback seems to be in the plans:

The Filing Persons acquired the Shares and Options (collectively, “Issuer Securities”) because they believe that the Shares are currently undervalued in the market place and represent an attractive investment opportunity. The Trian Group has met with Howard R. Levine, Chairman of the Board and Chief Executive Officer of the Issuer and members of senior management of the Issuer to discuss the Issuer’s business and strategies to enhance value for the Issuer’s shareholders. During these discussions, the Trian Group communicated its view that there is an opportunity to enhance shareholder value by improving the Issuer’s operational performance. The Filing Persons look forward to working with the Issuer on operating initiatives such as increasing sales per square foot to peer levels, improving the Issuer’s operating leverage and optimizing the number of new store openings. The Trian Group also discussed how the Issuer could utilize its capital structure and significant free-cash flow, including by considering the use of prudent amounts of leverage to increase the size of the Issuer’s stock repurchase program. In addition, the Trian Group provided examples of previous investments they (and/or entities affiliated with them) made in which they had helped create significant value by working together with management teams and boards of directors to improve operations and cash flows and enhance shareholder value.

Says the NYTimes.com in an article:

Family Dollar has been one of the retailers to benefit from the recession as more consumers come into its stores hunting for bargains. Family Dollar has seized on the opportunity, expanding its food offerings, lengthening store hours and accepting food stamps in all its stores. Peltz’s investment arm, Trian Fund Management LP, owns large stakes in a variety of major American businesses including upscale jeweler Tiffany’s & Co., food company H.J. Heinz Co. and fast-food chain Wendy’s/Arby’s Group Inc., of which Peltz serves as chairman.

FDO has been an extraordinary stock since the late 70s. It’s up around 24,000% excluding regular dividends. The last 5 years have not been as kind to the stock price, but it hasn’t been a disaster for shareholders either – the stock’s up 55% and the company has paid an increasing, regular quarterly dividend. It’s a situation worth watching.

No position.

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Barron’s has some interesting “sum-of-the-parts” analysis on the publicly traded limited partnership units of KKR & Co. L.P. (NYSE:KKR). Says Barron’s:

KKR ran $55 billion in assets across a variety of strategies as of March 31. Simply valuing the management fee stream from these assets at a 15 price-to-earnings multiple, in line with other money managers, and placing a lower multiple on its capital-markets unit, yields $3.25 or so per share in value, fully taxed. Adding the straight book value of its private and public direct investments produces another $6.25 per share, for a total implied value of $9.50, right at the present share price.

The next trick is valuing potential future performance fees on the $27 billion of deals housed in its private-equity funds, as well as those of deals not yet done and funds not yet raised.

One hedge-fund manager who has been buying the stock pencils in as plausible an 8% annual gain in the private funds, calculates the present value of the resulting performance fees (or the 60% of performance fees that flow to shareholders after employees get their taste) and gives this line item a 10 multiple to arrive at $3.70 a share in value. That produces a total sum-of-the-parts target above $13, more than 35% above the current price.

Analysts at Keefe Bruyette & Woods go even further, figuring KKR’s operating business to be worth $9 to $11 per share and the private-equity portfolio worth another $6.22 atop that, for a total value between $15.22 and $17.22.

Read the article.

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Market Folly has T2 Partners’ presentation to the 7th Annual Value Investing Seminar, in which they discuss three opportunities in BP, which I’ve discussed in the past, MSFT and BUD. Says Jay:

On Anheuser-Busch InBev, T2 Partners says, “you can currently buy BUD with an entry FCF yield of 10% for a business that can probably grow at GDP + inflation for a long time, giving you a long term IRR of at least 15% without any multiple expansion.” We’ve previously covered a separate and specific T2 Partners presentation on BUD worth checking out as well.

Secondly, Tilson and Tongue argue that Microsoft (MSFT) is undervalued. They write, “MSFT’s closing price on 7/12/10: $24.83, so assuming $2.40/share of FY 2011 earnings (midpoint of analysts’ estimates and our own), plus $4 share in cash, here are possible stock prices and returns (plus there’s a 2.1% dividend): 10x multiple = $28 stock = 13% return. 12x multiple = $33 stock = 33% return. 15x multiple = $40 stock = $61% return.” They highlight the company has $4.24 cash per share, shareholder friendly capital allocation (buybacks & dividend), as well as a new product cycle in tow (Microsoft Office, Windows 7, etc). T2 Partners says that the rumors of Microsoft’s demise are greatly exaggerated.

See the T2 presentation.

No positions.

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The WSJ has an article on Standard & Poor’s Valuation & Risk Strategies list of 10 publicly traded companies that could be LBO targets:

Analysts at S&P Valuation & Risk Strategies chose companies in the consumer discretionary and industrial sectors, because these sectors, along with financials, have been especially active for buyouts. Also, they picked companies that have market values of $1 billion to $4 billion, in keeping with the size of recent top LBOs. And finally, they picked companies trading at less than their respective industry’s coming year-end price-to-earnings ratio, which would indicate that the market currently undervalues them.

S&P’s top pick for an LBO is Eastman Kodak, with a market capitalization of roughly $1.2 billion. Private-equity firm KKR already owns a stake in Eastman Kodak. Here is the rest of the list:

  • Eastman Kodak ($1.2 billion)
  • Oshkosh ($2.8 billion)
  • GameStop ($2.9 billion)
  • EMCOR Group ($1.6 billion)
  • Cooper Tire & Rubber Co ($1.3 billion)
  • DSW ($1 billion)
  • TRW Automotive ($3.6 billion)
  • Dillard’s ($1.4 billion)
  • Alaska Air Group ($1.7 billion)
  • Gymboree ($1.2 billion)

Read the article.

No positions.

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The NYTimes has an article on Anthony Ward and his attempt to corner the cocoa market. The British news media has amusingly christened him “Chocolatefinger” in homage to the Bond villain Auric Goldfinger:

LONDON — To some, he is a real-life Willy Wonka. To others, he is a Bond-style villain bent on taking over the world’s supply of chocolate.

In a stroke, a hedge fund manager here named Anthony Ward has all but cornered the market in cocoa. By one estimate, he has bought enough to make more than five billion chocolate bars.

Chocolate lovers here are crying into their Cadbury wrappers — and rival traders are crying foul, saying Mr. Ward is stockpiling cocoa in a bid to drive up already high prices so he can sell later at a big profit. His activities have helped drive cocoa prices on the London market to a 30-year high.

Mr. Ward, 50, is not some rabid chocoholic, former employees say. He simply has a head for cocoa. And, through his private investment firm, Armajaro, he now controls a cache equal to 7 percent of annual cocoa production worldwide, a big enough chunk to sway prices.

Read the article here.

The article notes that attempts to corner markets come and go in the rough-and-tumble world of commodities trading. During the 1970s, Nelson Hunt and his brother, William, tried but failed to corner the world market in silver. For more on the Hunt brothers, see Silver Thursday: How Two Wealthy Traders Cornered The Market.

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Interesting commentary out of Minyanville (Today’s Market Is Missing Valuation, Fundamental Metrics) from a self-described “old valuation guy” lamenting the disappearance of value and value investors from the market. I usually enjoy these articles. I like sitting on Uncle Warren’s knee while he talks about the time he swapped a bag of cocoa beans for a controlling interest in Berkshire Hathaway:

For several weeks I busily bought shares, sold beans, and made periodic stops at Schroeder Trust to exchange stock certificates for warehouse receipts. The profits were good and my only expense was subway tokens.

Great story, Uncle Warren. I’m right now trying to buy Pfizer with a paper clip and some pocket lint, but I digress. I was just getting settled onto Old Valuation Guy’s lap when he springs this one on me:

One of the most frustrating aspects of the current market to an old valuation guy is the complete absence of a focus on fundamental valuation metrics and apparent lack of understanding of the relationship among leverage, growth, and value. Old Mr. Market is just not doing what he’s supposed to.

“Old Mr. Market is just not doing what he’s supposed to.” Say what? Isn’t the whole point of Ben Graham’s Mr. Market analogy that Mr. Market is a manic depressive who does silly things? What Mr. Market is supposed to do is act irrationally. You say he’s acting irrationally? He’s doing what he’s supposed to! I don’t think Old Mr. Market is the problem here. I think Old Valuation Guy is the one who’s not doing what he’s supposed to, which is to say, valuing things and taking advantage of Old Mr. Market. Reading between the lines, I think what Old Valuation Guy is saying is that the market refuses to go up. In my book, that’s not conclusive evidence that you’re not a value investor, but it’s strike one.

So-called Old Valuation Guy continues:

For those of us who grew up with a nod to Graham and Dodd, efficient market theory, or even discounted cash flow, this is one tough time, as increased volatility, whipsaw-like moves, and technical “tells” seem to be in ascension. Perhaps this is the inevitable volatility reflecting the combined uncertainty about the upcoming elections, the outlook for global recovery, and general economic uncertainty, and Mr. Market is merely going through the inevitable digestion required after the gluttony of the last decade; but I’d posit that there’s a bigger risk sitting in the wings.

Placing the words “efficient market theory” right after the words “Graham and Dodd” is vanishingly close to blasphemy. Wash your mouth out, and strike two. I’d give you a third strike for that line about “increased volatility” and “whipsaw-like moves”, but then you’d be out of strikes, and I want to send you to the showers for this gem:

Should investors and professional money managers come to believe that metrics like P/E ratios, TEV to EBITDA, book values, hurdle rates, or WACC are meaningless and antiquated tools in the current post-Armageddon financial meltdown, it may be a long time before folks come back to the market and provide the necessary liquidity to break us out of the doldrums.

WACC? WACC?? WACC is meaningless. And useless. And meaningless (Did I mention that?). Strike three. You’re outta here. I’ve got news for you, Old Valuation Guy: You’re not a value guy.

Value guys like volatility. Crazy, gyrating market? Giddyup. Whipsawing prices? Yee hah. “Uncertainty about the upcoming elections?” Beautiful. Follow that red herring. No liquidity? Along with raindrops on roses and whiskers on kittens, these are a few of my favorite things. Why? It is axiomatic to value investing that volatility is not risk, but the generator of opportunity. We want Mr. Market manic depressive for the rest of our lives. We want him bucking like a bronco. We want him scaring people away.

These articles pop up occasionally. Remember the article What Would Warren Do? where Megan McArdle interviewed a fund manager under the Omaha twilight who suddenly said, “The only way to make money these days is leverage”?  This sort of fuzzy thinking needs to be beaten back with a stick. If you’re going to go around calling yourself a value guy, at least have the common decency to find out what a value guy believes. A good place to start would be that Graham and Dodd book you nodded at as you were coming up.

Read the rest of it here. It improves slightly until he asks if “Edwards and Magee [have] finally beaten Graham and Dodd? Have momentum investing, computers, and flash trading killed the value investor?” Ugh. No.

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Greenbackd readers, get your exclusive $1,800 discount for the 6th Annual Value Investing Congress on October 12 & 13, 2010 in New York City. This offer expires in 8 days, so get your ticket now using dicount code: N10GB4.

The Value Investing Congress is the place for value investors from around the world to network with other value investors. I went to the May event earlier this year in Pasadena, and it was well worth it. The speakers seem to mingle freely and are generally available for a chat. Weather permitting, I’ll be in New York for this event.

Speakers include:

  • David Einhorn, Greenlight Capital Management
  • Lee Ainslie, Maverick Capital
  • John Burbank, Passport Capital
  • J Kyle Bass, Hayman Capital
  • Mohnish Pabrai, Pabrai Investment Funds
  • Amitabh Singhi, Surefin Investments
  • J. Carlo Cannell, Cannell Capital
  • Zeke Ashton, Centaur Capital Partners
  • Whitney Tilson & Glenn Tongue, T2 Partners

This offer expires midnight on July 30. Use using dicount code: N10GB4 and get your ticket now .

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The inestimable Market Folly has a wonderful post on East Coast Asset Management’s long case for Becton, Dickinson and Co. (NYSE:BDX). Jay says:

East Coast Asset Management is out with an in-depth presentation on Becton Dickinson (BDX). They lay out the bullish case for the company and assume that if you hold it for three years that an internal rate of return (IRR) on BDX if purchased now would be 17.6% annualized. … So, how do they come to this conclusion on BDX?

Let’s first start with the thesis behind this play. Anant Ahuja, Christopher Begg, and Jack McManus have laid out the model for East Coast Asset Management and point out that Becton Dickinson is a niche business with a diverse set of products aimed at capitalizing on the increasing amount of aging baby boomers. Shares have been under pressure due to concerns over exposure to Europe, weak 2009 sales, and unfavorable foreign exchange trends.

The stock currently trades at 8x EV/EBITDA, well below the historical 5 year average of 10.1x EV/EBITDA. They argue that the business has an intrinsic value of $90-95 per share, representing 35-40% upside in the stock. East Coast highlights that Becton Dickinson has an impressive past of shareholder value creation. Over the past five years, BDX has seen 23.5% ROIC, 22.2% ROE, EPS CAGR of 15.8%, and 37 consecutive years of dividend increases. Not to mention, the company has repurchased a consistent amount of shares, with $450 million allocated this year. Given that these are attributes Warren Buffett often likes to see in a business, it should come as no surprise that his Berkshire Hathaway added to its BDX position in the first quarter.

Download ECAM’s report here (.pdf via Market Folly).

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Andrew Shapiro, President of Lawndale Capital Management, has provided a further update on Reading International Inc (NASDAQ:RDI) (see the RDI post archive here):

In Reading’s 2008 Consolidated Entertainment/Pacific Theaters acquisition of 181 movie screens in California and Hawaii, there were three contingent purchase price reduction tests, each forgiving a portion of the acquisition’s seller note PLUS interest RETROACTIVE back to the Feb 2008 acquisition date. Two of those tests have already taken place and have reduced the seller note (“US Nationwide Loan 1” on Reading’s 3/31/10 schedule of Notes Payable) to $15.3 million.

This article notes the first anniversary of a competitive theater in Bakersfield California, within the competitive radius of Reading’s Valley Plaza 16, triggering the last contingent purchase price reduction test.

A multiple of the cash flow reduction experienced by Reading’s theater over this PAST year (that is lower EBITDA which RDI shareholders have already “suffered” from) is to be returned to Reading in the form of forgiveness on the seller note. The measurement will take place this current quarter.  Reading’s lowered debt from forgiveness of a portion or all of the US Nationwide Loan 1 and recovery of accrued interest expense on the forgiven principal RETROACTIVE to the Feb 2008 acquisition date is likely to occur during Q4, after Pacific Theater’s audit of Reading’s claim.

RDI has also announced that it has settled its tax dispute with the IRS. Here’s the release:

Reading International Settles Tax Case with IRS

Los Angeles, California, – (BUSINESS WIRE) – July 16, 2010 – Reading International, Inc. (Reading) (NASDAQ:RDI) announced today that its wholly owned subsidiary, Craig Corporation (Craig), has reached an agreement in principle to settle its tax dispute with the Internal Revenue Service (IRS) related to Craig’s tax year ended June 30, 1997. Craig and the IRS are currently in the process of documenting this settlement. The settlement resulted in a 70% concession by the government and will lead to the previously issued IRS Notice of Deficiency, dated June 29, 2006, in the amount of $20.9 million, $47.2 million inclusive of interest, being set aside by agreement of the parties. Reading estimates that, as of the date of this release, Craig’s liability under this settlement is approximately $15.0 million inclusive of interest, although final calculations have yet to be agreed. As of March 31, 2010, Craig had reserved $4.5 million against this liability.

The impact of this settlement with the IRS on Reading is approximately $14.0 million, resulting in a charge against earnings of $9.5 million for the second quarter.

[Full Disclosure:  I hold RDI. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

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Hervé Jacques has provided a guest post on the accuracy of guru prognostications. Here’s Hervé’s bio:

Hervé is a veteran of 30-year of market activity on the official sector side (central banks, International Financial Organizations) with first hand experience of FX and fixed income markets. He is now consulting for official and private institutions, targeting International financial organizations, sovereign wealth funds, central banks, commercial and investment banks, hedge funds.

In parallel to his professional career, he has a successful track record as a personal investor in stocks, bonds and commodities over several decades.

His market experience from an unusual perspective (the nexus between policy making and investors/traders) gives him unparalleled insight into the post-crisis world of capital markets.

Hervé Jacques on Guru Calls: Better lucky than smart?:

I came across this today, by accident. Check the date. Yes, it’s 2009.

Makes you modest, doesn’t it? That was back in May 2009. So David got it almost exactly right, month-wise. He was just a year early, as the market didn’t peak until April 23rd, 2010, so about 12 months later. The S&P500 went all the way from 920 to 1217 during those 12 months.

And this was coming from one of the (rightfully) most respected Wall Street voices, at the top of his career, crowning many years of leading presence at Merrill on his valedictorian interview.

Not picking on him here: there are dozens of examples of such calls ending way out of the ballpark, starting with quite a few of mine…

In 2001, the IMF did a 63 country-study on how well economists predicted recessions. The punch line of the result?

“The record of failure to predict recessions is virtually unblemished.”

Goes to show that both the economy as well as Mr. Market do as they please, no matter how intricate the research, how strong the gut feeling and how extensive the experience of whoever places calls, especially as regards the future of stock prices.

David’s point was right, mind you. I would subscribe even today to everything he said, on the fundamentals.

Nevertheless, the “animal spirits”, “market sentiment”, “investor psychology” or whatever you call it meant that Mr. Market would keep going strong for another year, despite all the appropriately highlighted issues.

So where does that leave us? Taking cheap shots at highly respected gurus? Nope.

The lesson is that no matter how authorized the voices, whatever they come up with is one of the potential “states of the world” that will materialize. There is this somewhat sarcastic saying that “promises only commit those that receive them”. I think it applies to forecasting as well.

Any forecast, no matter how carefully crafted, is a probability. Nothing more than that. Which explains, by the way, why we get so many different forecasts, based on so many different expectations, which make the market that superior voting and weighing machine described by Ben Graham.

So next time we read some intricately motivated forecast from a star Wall Street authority, let’s keep in mind that this is just as much as the human mind-at its best? -can conceive, but that reality will result of the competing expectations of millions of other “votes”.

Not necessarily better-informed “votes”, by the way. Which means that the outcome might be less “efficient” than the most carefully forecasted one. Being smart does not always lead to riches, as “the market can stay inefficient longer than you can stay solvent”, as we know.

So, away from philosophy, what does that mean in real trading life?

The practical consequence is that, no matter how strong the gut feeling, how grounded the analytics and how big the firepower backing it, any market position is a bet that needs to be backed by a stop-loss (“risk management”).

Any such position is only based on the existing information (public or private).

Therefore two things can derail the plans: new information (potentially “black swans”, but even more mundane events); and an unexpected reaction of other players (“Mr. Market”) to the existing information. That’s more than enough to mess up the best plans.

As my mom used to say: “Better lucky than smart”.

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