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Archive for September, 2010

Harry Long of Contrarian Industries has a great guest post on SureWest Communications (SURW). Harry is the Managing Partner of Contrarian Industries, LLC and can be reached at info@contrarianindustries.com (mailto:info@contrarianindustries.com):

SureWest Communications (SURW) is a fascinating study in capital allocation, which is the most important strategic imperative in an industry with stagnant growth. For the past 3 years, SureWest has averaged a little over $60 million in cash flow from operations, yet amazingly, trades at a $91 million market cap, giving it a Price to Cash flow ratio of less than 1.50X.

Why is the stock so cheap? The answer is simple. The company does not pay a dividend, and cash flow has been pretty steady for many years. In addition, SureWest has plowed back much of its cash flow into capital expenditures, upgrading its network to compete in the broadband space, as traditional phone service revenue has declined.

I would argue that even though broadband revenue growth has kept overall revenue and cash flows stable, that now is the time to reward stockholders. At the beginning of 2000, SureWest’s stock sold at $32.88 a share. On September 27th, the stock closed at $6.54 a share. Over a decade, shareholders have been clobbered. They deserve the very best form of shareholder value after such punishment and such a long wait—a dividend check in the mail every quarter!

On September 27th, I spoke to SureWest CEO Steven Oldham. He was clear that maintenance capex, calculated conservatively, was $15 million per year. In my opinion, that means SureWest could comfortably dividend out almost $45 million a share per year, which would equate to a dividend of $3.20 per share annually.

Dividend yields on telecommunications companies top out at around 10%. If SureWest instituted a $0.80 per share dividend paid quarterly, I believe its stock would quickly shoot to $32.00, giving it a 10% yield, which would be comparable to the upper end of the dividend yield range for other Telcos.

On September 23rd, SureWest announced that the board increased its share repurchase authorization, “which increases the total amount previously available for repurchase under the program from approximately 253,000 shares to approximately 1,253,000 shares.”

Since then, the stock has jumped. This is a fair start to build on. However, it is not nearly enough. The best increase in shareholder value comes from a dividend check in the mail. A repurchase authorization is just that—an authorization. It does not force the company to buy back stock. The type of dramatic increase in shareholder value, which shareholders deserve after suffering heavily for over a decade, is a fat dividend of $3.20 per share annually.

The reality is that fiber-based telcos have not grown quickly for years. Competition in the telecommunications industry is intense. Pricing competition is intense. You can be a brilliant operator, but competitors are likely to match any move to either lower pricing, or offer more services. Hence, the customer benefits, but shareholders rarely earn substantial returns without scale. The Comcasts of the world have scale, and some moderate advantages. They can squeeze a smaller competitor. They can afford to spend more. SureWest cannot, in my opinion, outspend a large competitor. Therefore, they need to dividend out their cash flow, improve shareholder value, and/or negotiate a sale to a larger competitor.

Executives, as fiduciaries, are stewards of capital. It is very tempting to have the mentality that the job of a Telco executive is to grow the company, even if vast amounts of capital have to be sunk into it at very low returns on capital. However, growth at low returns on capital can be destructive to shareholder value, because the capital could best be deployed elsewhere. The real test of character is whether executives love the business of buying vast amounts of equipment which earn low returns on capital, or whether they love their shareholders. If SureWest executives truly want to behave as first-class fiduciaries, I would argue that their duty is to shovel money back to shareholders, who can find better returns in other industries on their own.

As Warren Buffett said, “When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.” Recognizing that truth is imperative for SureWest’s executives, even if they have brilliant plans that they believe will allow the company to grow. For a reality check, revenue at SureWest last quarter decreased by almost 1% from a year ago. When it comes to growth, “show” means much more than “tell.”

CEOs are intensely competitive and do not lack in confidence. As such, they systematically over-estimate their ability to extract shareholder value from intensely competitive industries. They often truly delude themselves in to thinking that they will be special, that they will not suffer the fate of the other small players in the industry. But they are almost invariably wrong.

We do not need to be prophets to reasonably predict what will happen if all cash flows are continually sunk back into the company. We need to look at the past. In 2000, SureWest’s stock sold at $32.88 a share. Since then, hundreds of millions have been sunk into capex. On September 27th, SureWest’s stock sold at $6.54 per share. Most Telco mangers are human. They love running and growing Telcos. It is more an engineer’s perspective than a business perspective. SureWest shareholders, however, have suffered from this perspective, in my opinion, with a very cheap stock price and decimated shareholder value. Shareholders deserve a radical change in strategy.

Charlie Munger and Warren Buffett have often pointed out that the best managers are excellent capital allocators. SureWest is at a classic capital allocation fork in the road. I predict that if SureWest does not change their capital allocation strategy, that shrewd acquirers and activists will become involved. They will either see the company as a great potential vehicle, like the original Berkshire Hathaway (BRK.A), or will turn the company into a dividend machine themselves, if management refuses to.

Even if activists or financial acquirers do not make a run at the company, SureWest would be in a far better negotiating position with a potential strategic acquirer, such as Comcast, with a higher stock price. A stock price of $32 per share would be a great touchstone for negotiations. In every mature industry, management often says a version of “Trust us. Next year will be better. If we just plow a little more money into it, we’ll see a return.”

As Charlie Munger has pointed out, people are easy to fool, and the easiest people to fool are ourselves. Confirmation bias rules the day. Any dis-confirming evidence is likely to be ignored. For years, the auto industry said the same thing to shareholders. We all know how that ended. As Buffett has often pointed out, “A girl in a convertible is worth five in the phonebook.” Shareholders can have dividends today which will increase shareholder value if they are declared by the board now. Dividends today are far more valuable than promises of rosier days ahead for Telcos.

In 2009, CEO Steven Oldham received $1,361,140 in total compensation. I do not begrudge him such compensation, so long as he does not begrudge stockholders a large dividend. Everyone deserves to be treated fairly—especially shareholders. Shareholders need to be put first—capex should be at the back of the line.

SureWest would make a fantastic vehicle. Cash flow could be redeployed to many other industries, to great advantage. Buffett and Munger have seen this playbook before. After all, they wrote it!

If CEO Steven Oldham sees the light and starts supporting huge dividends, he will become a hero to shareholders in this industry. However, if he does not, the board should replace him with someone who wants to reward shareholders now. After all, shareholders have waited for the rewards of ownership for 10 years. They should not have to wait any longer.

Disclosure: Author is long SURW

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The excellent Above Average Odds Investing has a great analysis of Visteon Corporation (VSTNQ). Here’s the pitch:

Thesis:

The Visteon Corporation is a classic post reorg/special situation with a large margin of safety and substantial near-term upside potential.

Brief Business Description:

Visteon Corporation is a global Tier 1 supplier of automotive products to original equipment manufacturers (OEM’s). Visteon is a market leader in each of its three core product groups: climate, electronics, and interior systems. Visteon is geographically diversified and is not overly reliant on any one particular OEM. The company’s three largest customers are Ford, Hyundai/Kia, and Nissan/Renault (which make up 29%, 27%, and 9% of the company’s revenues respectively).

Opportunity Overview:

Visteon’s shares are currently trading on a “when issued” basis at roughly 3x 2011 EBITDA, and after backing out the company’s significant ownership in high growth subsidiaries, we believe the core Visteon business trades for between 1.5x and 1.7x EBITDA. Given Visteon’s multiple internal and external catalyst’s, highly attractive absolute valuation and the outsized spread between the company’s “when issued” shares and the already depressed valuation’s of its global competitors, we think that the stars are aligning for bargain hunting investors to generate spectacular returns of 30%+ in a short period of time with relatively low risk. Keep in mind that this isn’t “your father’s” Visteon, as the company will exit bankruptcy permanently improved and completely transformed, offering investor’s both a 1) quick, high-return, relatively risk-free arbitrage and/or 2) an inexpensive way to play any upturn in – or at least the stabilization of – global auto sales and economic activity in general.

The idea here is simple. As Visteon exits chapter 11, the near to medium-term upside will likely be driven by a combination of 1) a couple of imminent, high probability catalyst’s that should force the market to assign this company with a much more appropriate valuation on an absolute basis and relative to its peers and 2) various operational and financial enhancements that the company recently undertook while in bankruptcy should continue to yield visible and increasingly positive operating results for the foreseeable future.

Our expectation is that the initial roughly 30%+ will come almost instantaneously (within a month or so) as 1) the stock begins to trade regular way 2) equity analysts initiate coverage and 3) various institutional and index funds that have been unable to purchase the stock up until this point (due to restrictions on purchasing company’s in Ch. 11), begin buying in droves. Notably, the return assumption above assumes that upon re-emergence the company trade’s at an incredibly non-demanding multiple of 3.75x EBITDA or, to put it another way, in line with the cheapest automotive suppliers within the industry as a whole. Keep in mind that we think this estimate is very (almost unjustifiably) conservative given that on average Visteon’s peers tend to be considerably more levered, and typically possess both lower EBITDA margins as well as less attractive long-term growth prospects.

Read the post.

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NYmag.com has a great profile on David Tepper, whose talk at the Ira Sohn investment conference some are crediting with the run up on Friday. The profile is the standard form hagiography for someone coming off a big win, but there is some interesting discussion of the positions Tepper was taking in March 2009:

Last year, when the market effectively crapped itself, Tepper’s firm, Appaloosa Management, made a fortune rolling around in it. In February and March 2009, when consensus had coalesced among market watchers that certain financial institutions were insolvent and would have to be nationalized, triggering a massive sell-off that drove shares of companies like Citigroup and Bank of America into the single digits, Tepper decided to tune out the chatter. After all, the Treasury Department had said it would hold up the banks—why wouldn’t they keep their promise? He directed deputies at his firm to purchase billions of dollars’ worth of bonds and stocks in those and other financial institutions. Then they waited.

At the time, taking such a position was like swimming into the ocean as a tsunami approaches: It looked crazy. But actually it was the right thing to do. When the government intervened as promised, the value of the shares shot back up. Appaloosa made over $7.5 billion. Not bad for a tiny fund from New Jersey.

There’s also some interesting back story on the formation of Appaloosa, his first fund:

In 1993, with a few big scores under his belt and an investment from Jack Walton, a fellow Goldman junk-bond trader who agreed to become a partner (he has since retired), he started up Appaloosa. Since then, the fund has grown in adolescent fits and starts. Distressed investing is a tricky area: When you’re purchasing the garbage of a troubled company, hoping to find something valuable you can pawn, it’s “feast or famine,” as one investor puts it. Year to year, Appaloosa’s rate of return is wildly uneven. In 1998, Tepper bought a bunch of Russian debt on the assumption that the Russian government wouldn’t default. When it did and the ruble collapsed, it cost his fund hundreds of millions of dollars. But even as the market tanked, Tepper kept buying the ever-cheaper bonds, and a few months later, his tenacity paid off: The fund went up 60 percent.

A similar situation occurred in 2002, when the junk-bond market collapsed for a second time. Tepper lost 25 percent, but made up for it the following year, when bonds he’d purchased in bankrupt companies went up 150 percent. He took home $500 million, at the time a personal best, and the following year made his donation to Carnegie Mellon.

And the story of how he got some brass balls on his wall:

Tepper has a pair of brass testicles.

The balls were a gift to Tepper from a former employee—Alan Fournier, who now runs his own fund, Pennant Capital Management—in the wake of Tepper’s big score in 2003. Tepper had purchased the distressed debt of the three then-largest bankruptcies in corporate history: Enron, WorldCom, and insurance giant Conseco. When they emerged from bankruptcy and the debt appreciated, Appaloosa went up a whopping 148 percent.

Read the article.

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The NYTimes.com Business Day Media & Advertising section had a story last week about Randall D. Smith, a “pioneer in the hard knocks business of vulture investing” and his current focus on the newspaper industry:

Mr. Smith puts money into risky investments that few others will touch — and these days, that includes many newspaper and radio companies.

For the better part of a year, Mr. Smith has been quietly building a fledgling media empire. He has invested millions of dollars in small and midsize newspaper chains, as well several radio broadcasters.

His exact ambitions are unclear. But industry executives and analysts say Mr. Smith — who made money investing in troubled companies after the junk-bond market collapsed in the 1980s — is clearly betting that he can eke out profits despite the industry’s running troubles.

Smith is not the only investor interested in newspapers:

Mr. Smith is not the only vulture investor watching the media industry. A handful of hedge funds, as well as some big banks, are vying for ownership or have already gained controlling interests in newspapers across the country, including The Los Angeles Times, The Minneapolis Star Tribune and The Chicago Tribune.

Hedge funds have even grabbed stakes in supermarket tabloids like The National Enquirer and Star Magazine, as those companies have undergone rounds of restructurings.

Funds also gained the upper hand for the television broadcasting company Ion Media Network and the publishing and educational materials company Houghton Mifflin Harcourt.

Smith’s m.o. is deep value:

Vulture investors like Mr. Smith often buy up the debt of weak companies for pennies on the dollar, hoping to turn a profit when the companies go through bankruptcy or restructure their businesses. Often they hope to swap the debt for equity. But some analysts wonder how, or whether, the vultures can steer some of these companies through the unprecedented upheaval in the industry.

“These people have been bottom feeders, and they figure what they’re getting is still a valuable, though diminished, franchise and they’re willing to pay bottom dollar for it,” John Morton, a newspaper industry analyst, said of these investors. “But it’s unclear that this industry is going to get a whole lot better.”

Nonetheless, some big vulture investors seem to be betting that the industry’s worst days are over, or that, at the least, that further cost cutting or consolidation can slow the bleeding, analysts said.

Smith has a great track record:

But analysts and industry executives are keeping a particularly close eye on Mr. Smith. He has been one of savviest and stealthiest investors in the media realm in the past year and a half, they say.

Mr. Smith started his own brokerage firm, R.D. Smith & Company, in 1985, after spending years climbing the ranks of Bear Stearns. For the past decade or so, he has quietly tended to running money for himself and his family.

But in late 2008, he opened a new fund which surged an astonishing 187 percent last year. This year, however, the fund was up only 2.9 percent this year through the end of July, according to Absolute Return + Alpha, an industry magazine.

In a letter to investors in April, the firm said the fund held significant positions in 15 companies and that two of the current themes were distressed financials and media companies.

In recent months, Mr. Smith has built up a significant stake in MediaNews Group, a publishing company that owns The Denver Post and San Jose Mercury News, as well as The Journal Register, which controls 170 titles, including The New Haven Register and The Trentonian.

Read the article.

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Last month I sat down for an interview with Geoff Gannon from Gannon on Investing. Geoff is a superb value investor in his own right, and a student of the markets. He asked some fantastic questions, and we covered a great deal of territory in the 1 hour 15 minute interview. One subject we touched on was the issue of “bottom-up, fundamental” versus “top-down macro” investing styles, a topic that has received some attention overnight in the WSJ (see ‘Macro’ Forces in Market Confound Stock Pickers). Many thanks to Geoff for the opportunity.

Listen to the interview.

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The Street has an article Companies That Serve as Buyout Targets advocating a Darwin’s Darlings / Endangered Species-type strategy for buying stock:

When evaluating small-cap stocks, individual investors would do well to emulate private-equity professionals.

Focusing on balance sheets and private-market valuations of small companies cuts through the noise sounded by volatile stock markets like today’s. After all, price isn’t always indicative of value. The difference between the two can mean big profits for discerning investors, says Mark Travis, chief executive officer of Intrepid Capital Funds.

Travis uses such a strategy to determine the price that a rational buyer, paying cash, would offer for a company. Many companies he follows are growing fast and generating a lot of cash, but retail investors know very little about them because they fly under Wall Street’s radar.

Travis says companies that generate cash consistently attract suitors, either larger companies in their industry or private-equity firms. If neither comes forward, Travis is happy knowing the investment will continue to grow as the company’s cash builds up.

Stable businesses with little debt tend to be winners, Travis says.

“That makes them durable when you go through some of the bumps we’ve been through in the last three to five years,” he says. “We’re not trying to front-run Steve Schwarzman at Blackstone (BX). We just happen to like the characteristics of cash generators.”

Three of the companies on Travis’s list are as follows:

  • Tekelec (TKLC):

Travis’ Take: “This is an off-the-radar pick. It’s an example of a company that has a really beautiful balance sheet and a share price trading at a low multiple. This trades at 12 times earnings. There’s no debt and there’s $226 million in cash. Almost a quarter of the market cap is in cash. You’re able to buy it at a little over five times pretax cash flow. We think those shares are worth in the high teens.”

  • Aaron’s (AAN)

Travis’ Take: “People don’t realize with the financial-regulation bill that credit won’t be more available; it’ll be less available. This company has 1,700 stores with about 1,000 of those franchised and about 700 corporately owned. At $16, it has a 12 multiple and a beautiful balance sheet. It has $54 million in debt but $85 million in cash, so they have net cash on their books. It’s a good business and could trade in the mid-20s.”

  • Tidewater (TDW)

Travis’ Take: “They service offshore oil rigs, which certainly have gotten a lot of negative press. But they have a clean balance sheet, with $300 million in debt and cash of $122 million. Less than 10% of revenue comes from servicing rigs in the Gulf of Mexico. It trades at less than 10 times earnings and you get a dividend of 2.4%. We think the shares are probably worth $53 or $54.”

Read the rest of the article.

Long TDW.

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Lawndale Capital Management has filed an amended 13D for P & F Industries Inc (NASDAQ:PFIN) (see the PFIN archive). The filing seems to have been triggered by Lawndale’s President Andrew E. Shapiro’s September 17, 2010 letter to PFIN’s Board and an increase in Lawndale’s ownership position to 9.7% of PFIN.

The “Purpose” language of the filing is set out below:

As disclosed in prior filings, the Filers (“Lawndale”) have been in contact with P&F Industries (“PFIN”) management and members of PFIN’s Board of Directors (the “Board”) regarding certain operational and corporate governance concerns that include, but are not limited to, what Lawndale believes to be excessive compensation paid to PFIN’s Chairman and CEO, Richard Horowitz, for poor performance.  This leads to additional serious concerns Lawndale has regarding the Board’s composition and independence.

In February 2010, Lawndale submitted the names and backgrounds of five highly qualified and independent individuals for possible addition to P&F’s Board. Around May 4, 2010, PFIN mailed proxies for its 2010 Annual Meeting containing only its current board members as nominees for election to new 3-year terms.  On May 25, 2010, Lawndale sent PFIN’s Board a letter (the “May 2010 Letter”, a copy of which is attached as Exhibit 1 hereto, and incorporated by reference to this filing) informing them of Lawndale’s intent to vote its shares, then equal to 7.5% of PFIN, to “Withhold” on the re-election of PFIN’s nominees.  The May 2010 Letter to PFIN’s Board set forth Lawndale’s rationale for its concerns and vote, the major points of which were that:

  • Horowitz’ compensation is wholly inappropriate for P&F’s small size and holding company structure
  • The only shareowner to benefit from the Horowitz era has been Horowitz
  • P&F’s board requires increased independence by means of new directors from outside “the club”

Leading independent proxy advisory services Proxy Governance and RiskMetrics both criticized P&F’s corporate governance (and in the case of Proxy Governance, its excessive CEO compensation as well) and recommended Withhold votes for its clients. Voting results from the June 3, 2010, Annual Meeting disclosed roughly 30% of the votes cast for each of the nominees were voted Withhold.

Subsequent to the 2010 Annual Meeting, PFIN has taken some rudimentary steps towards improving its corporate governance, including, on July 29, 2010, expanding its Board to nine directors by adding to its Board one of the five individuals recommended by Lawndale.

On September 17, 2010, Lawndale sent PFIN’s Board a letter (the “September 17th Letter”, a copy of which is attached at Exhibit B hereto, and incorporated by reference to this filing) informing them of Lawndale’s increased ownership in PFIN and that Lawndale viewed PFIN’s changes to date as cosmetic. It is the view of Lawndale that a board comprised of qualified directors who are independent, and whose interests are better aligned with shareholders via meaningful purchased equity ownership, would more objectively and aggressively oversee the compensation and corporate acquisition and disposition decisions of PFIN.

In the September 17th Letter, Lawndale requested that PFIN’s Board:

  • Improve its independent composition and reduce its size by removing or replacing conflicted directors, particularly Director Dennis Kalick, one of Mr. Horowitz’ personal tax advisors
  • Consider strategic alternatives, including the sale of the company for a control premium to a synergistic buyer, prior to renewing Mr. Horowitz’ contract
  • Reduce or eliminate the egregious compensation terms such that any new contract with Mr. Horowitz contains lower “guaranteed” base compensation, greatly reduced supplemental profit sharing payments, and no “Golden Parachute” severance terms

Lawndale has offered to source additional director candidates to PFIN’s Board as needed, and requested a meeting or conference call with PFIN’s Board to discuss constructive actions to further improve corporate governance and maximize value for all P&F shareowners.

Lawndale believes the public market value of PFIN is undervalued by not adequately reflecting the value of PFIN’s business segments and other assets, including certain long-held real estate.

While Lawndale acquired the Stock solely for investment purposes, Lawndale has been and may continue to be in contact with PFIN management, members of PFIN’s Board, other significant shareholders and others regarding alternatives that PFIN could employ to maximize shareholder value. Lawndale may from time to time take such actions, as it deems necessary or appropriate to maximize its investment in the Company’s shares. Such action(s) may include, but is not limited to, buying or selling the Company’s Stock at its discretion, communicating with the Company’s shareholders and/or others about actions which may be taken to improve the Company’s financial situation or governance policies or practices, as well as such other actions as Lawndale, in its sole discretion, may find appropriate.

The letter exhibit by Lawndale can be found here.

Disclosure: No position

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