Archive for October, 2010

Top posts for the quarter

Folks, I’m traveling this week to the Value Investing Congress in New York (it’s nearly sold out, but tickets are still available. Come and say, “Hello.”) I won’t be maintaining my usual posting schedule while I’m here. In the mean time, here are the top posts for the quarter:

  1. The long and short of Berkshire Hathaway
  2. Mr. Market refuses to do what he’s supposed to, apparently
  3. Graham / Shiller PE10 calculated using ShadowStats CPI
  4. Greenbackd Contrarian Value Portfolio Update
  5. Guest post: Seahawk Drilling Inc (NASDAQ:HAWK) and the Hacienda
  6. Quant funds don’t perform like a good quant fund should
  7. East Coast Asset Management on Becton, Dickinson and Co. (NYSE:BDX)
  8. Handy automatic Graham / Shiller PE10 chart
  9. Darwin’s darlings in practice
  10. The long and short of The St. Joe Company (NYSE:JOE)

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LCV Capital Management and Raging Capital Management are running an activist campaign against ModusLink Global Solutions(TM) Inc (NASDAQ:MLNK) calling on MLNK to immediately implement a $50 to $75M share repurchase program and align executive compensation with performance. The two fund managers, calling themselves “The ModusLink Full Value Committee,” say that the full potential of MLNK is not being realized due to shortcomings in MLNK’s “operational and capital market strategies” and has “concerns regarding the Company’s corporate governance practices.”  The committee has nominated a slate of three independent director nominees for election to the board at MLNK’s upcoming annual meeting of shareholders.

The full text of the letter follows:

Raging Capital Management, LLC254 Witherspoon Street

Princeton, New Jersey 08542

LCV Capital Management, LLCFifteen Churchill Road, Suite 1000

Pittsburgh, Pennsylvania 15235

October 7, 2010

The Board of Directors

ModusLink Global Solutions, Inc.

1100 Winter Street

Waltham, MA 02451

To the Board of Directors of ModusLink:

The ModusLink Full Value Committee (“The Committee”) owns approximately 5.5% of the outstanding shares of ModusLink Global Solutions, Inc. (“ModusLink” or the “Company”).  We are well informed, long-term investors who have met with senior management and several board members on numerous occasions since representatives of The Committee began investing in ModusLink in 2008.

As we have communicated to you, we believe that the full potential of the Company is not being realized due to shortcomings in the Company’s operational and capital markets strategies.  We are concerned about the Company’s strategic direction, approach to capital allocation, and weak governance oversight.  In our opinion, these factors are key contributors to ModusLink’s lackluster stock price performance over the past several years.

Our view is that ModusLink has a tremendous opportunity to unlock and drive substantial shareholder value.  The Company’s $174 million in cash and investments are equal to approximately $4.00 per share, and working capital on hand exceeds $220 million, or 80% of the Company’s current market capitalization.  Yet the Company’s enterprise value totals just $120 million, or less than three times its Fiscal 2010 EBITDA of $46 million.  Unfortunately, the Company will likely continue as a chronic underperformer in the marketplace until change is implemented.


Shareholder value has been destroyed via a series of poorly timed and poorly executed business acquisitions by ModusLink.  Since 2004, ModusLink has spent more than $315 million on acquisitions, including $87 million on three separate businesses acquired since 2008.  The Company has since taken material goodwill impairment charges on the bulk of these acquisitions in the last two years.  With a current enterprise value of $120 million, it’s fair to say that the return on deployed acquisition capital over the past six years has been abysmal.

Instead of making additional acquisitions, we believe the Company should focus on optimizing and streamlining existing operations, while divesting underperforming and non-core assets.  We believe a simpler, more transparent business would be easier for management to operate and for investors to comprehend and support, thus leading to improved operating results and shareholder returns.

Furthermore, given the relative stability of the cash flows of the Company’s core business, the significant discount to intrinsic/replacement value that the stock currently trades at, and the strength of the balance sheet, we believe ModusLink should immediately implement a $50 to $75 million share repurchase program.  This would be highly accretive to shareholders and magnify the potential upside of any improvement in the Company’s operating results.


We have also communicated to you our serious suggestions to improve ModusLink’s corporate governance shortcomings. While many publicly traded companies have prudently separated the respective roles of Chairman and CEO, ModusLink continues to operate under an archaic structure where the Chairman also holds the position of CEO and President.  This structure fails to provide the appropriate checks and balances needed between the Board and management and engenders a harmful and value-destroying perception by the market of a general lack of accountability.

We are also deeply concerned that this Board has failed to align executive compensation with performance.  According to the Company’s 2009 proxy statement, ModusLink paid out more than $13.8 million to its top three senior executives over a period of three years while Company’s market value declined by hundreds of millions of dollars. This is not acceptable to us as active and concerned shareholders.  It is noteworthy that we are not alone in our opinion on this matter: At last year’s annual meeting, one of the leading corporate governance and proxy advisory firms recommended that shareholders withhold their vote against the election of the chairman of the compensation committee because of the Company’s propensity to overcompensate management for an underperforming stock.  We firmly believe that, in accordance with its fiduciary obligation to shareholders, it is imperative that the Board aligns compensation with the enhancement of shareholder value, since shareholders are the true owners of the Company.

We propose that part of the failure to align compensation with performance can be traced to the low level of stock ownership held by senior management and the Board.  In fact, excluding ModusLink’s Chairman & CEO, the other six members of the board own approximately 35,000 shares in total, or less than one tenth of one percent of the Company.


As significant shareholders, our objective is to see the full value of our shares and the shares of all other owners of this Company be recognized in the marketplace.  We are committed to working on behalf of all shareholders to ensure that shareholders’ interests are represented in the boardroom.

As you know, we have nominated three individuals to fill the director positions up for election at the Company’s next annual meeting.  All three of our nominees have the appropriate skills and fortitude to implement the significant changes necessary to benefit all ModusLink shareholders and we believe they will be valuable additions to the Board.

We continue to welcome an open dialogue with you but to date we have been unable to reach an understanding with the Company that will result in the Company immediately taking the necessary steps to unlock shareholder value.  Our sincere hope is that this Board will take a fresh look at the opinions we have outlined above and take immediate action to embrace change rather than engage in a protracted and costly proxy contest in an effort to preserve the status quo.

We remain open to speaking with you at any time.


/s/ Lodovico C. de Visconti


Lodovico de Visconti

Managing Member, LCV Capital Management, LLC

/s/ William C. Martin


William C. Martin

Managing Member, Raging Capital Management, LLC

The company responded in a press release yesterday:

WALTHAM, Mass.–(BUSINESS WIRE)– ModusLink Global Solutions(TM), Inc. (NASDAQ:MLNK), today issued the following statement in response to the public letter from dissident hedge funds, LCV Capital Management, LLC, Raging Capital Management, LLC and certain of their affiliates:

ModusLink values the opinions of all stockholders and strives to maintain an open dialogue with them. To that end, members of ModusLink’s senior management have met with LCV and Raging Capital representatives on numerous occasions, and throughout the discussions the Company gave these dissidents every indication that their concerns could be resolved in a manner that would be beneficial to all stockholders.

ModusLink’s directors, six of seven of whom are independent, are all highly qualified and committed to represent the best interests of all ModusLink stockholders. Consistent with their fiduciary duties, members of the Board’s Nominating and Corporate Governance Committee have interviewed each one of the dissident nominees and are in the process of evaluating their qualifications.

ModusLink recommends that stockholders defer making any determination with respect to the letter from LCV and Raging Capital, which distorts the Company’s record on a number of matters, until they have been advised of the Board’s evaluation of the dissident’s nominees and proposals.

ModusLink remains firmly committed to creating value for all its stockholders through the successful execution of the Company’s strategy. The Company’s Board and management have taken actions to improve the financial and operational performance of the Company and create value for stockholders, including:

  • Investing $55.3 million to repurchase shares since early fiscal 2008. In total the Company has purchased 5.6 million shares, which represents 12% of the fully diluted outstanding share count at the time the program was first announced.
  • Effectively managing through a very difficult economic environment, taking decisive actions to reduce expenses and maintain a strong balance sheet.
  • Focusing on maximizing profitability, resulting in record free cash flow from operations in fiscal 2010.

It’s an interesting situation worth watching. The record date is next Friday, so stock buying will have to be complete by Tuesday for trades to clear in time for votes to count at the annual meeting.

No position yet.

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Fortune has an article asking whether VCs can be value investors:

After all, the philosophy of value investing, in theory, should cut across all asset classes and managers. The precepts and principals therefore should apply to the venture capital business as well.

Sadly, they don’t.

Jeffrey Bussgang, the author, identifies the problem as an inability to invest with a margin of safety:

Klarman writes: “Investing in bargain-priced securities provides a “margin of safety” — room for error, imprecision, bad luck, or the vicissitudes of the economy and stock market.”

Unfortunately, VCs don’t operate with a margin of safety, even if they are able to find and negotiate good deals. Later stage investors may have downside protection if they buy smart, but early-stage VCs do not. If a portfolio company goes bad, there is typically barely any salvage value.

I don’t know that venture capital investing necessarily means investing without a margin of safety, but I agree that many early stage investments lack a margin of safety.

An estimate of intrinsic value is key to determining a margin of safety. Early stage businesses by definition lack a track record, and – BYD aside – not even Buffett can value a business without a track record. It is more difficult when the business has promise, but is burning cash, if only because the blue sky makes it easier to ignore the ugly financial statements.

Confronted with this state of affairs – no track record, no ability to see the future – most value investors would do as Buffett suggests and simply refuse to swing. This is one of the nice things about value investing. You don’t have to know everything about everything, or even much about anything. All you have to know is what you do know, and what you don’t know, and the location of the line separating the two.

Venture capitalists, however, must know stuff about the future, and must be able to “see around corners” (seriously?). To the extent that venture capitalists undertake any sort of valuation that a value investor might recognize, they must extrapolate revenue growth from non-existent revenue, hope that some of it eventually falls to the bottom line, and then into the hands of shareholders, and plug it into a model with the Gordon Growth Model (GGM) at its heart. (As an aside, I could barely type with a straight face that part about venture capitalists waiting for the dividends. I know they “exit” in a trade sale or IPO, which I guess is a euphemism for “sell to a greater fool.”)

Every value investor knows that big growth assumptions in the GGM – even those based on a historical track record – are a recipe for disaster. Why? Simply because the growth is always going to be so astronomical as to overwhelm the discount rate portion of the model, leading to a “Choose your own value” output. To wit:

Value = D / R – G

Where D is next year’s dividend, R is your discount rate and  G is the perpetuity growth rate

If R is say 10-12%, any G over 9-11% gives a value that is more than 100x dividends, which is pricey. I doubt there are any VCs getting out of bed for 10% growth assumptions, so I assume they crank up their discount rates, but the result is the same. As G approaches R, value approaches infinity, and, in some instances, beyond. The solution to this problem is obviously to assume a short period of supernormal growth and then a perpetuity of GDP (or some other, lower) growth figure. This just creates another problem, which, for mine, is too many assumptions, and too many moving parts to get a meaningful valuation.

In this vein, I had a chat with a friend who is a value guy about Facebook’s “valuation”. He says:

Originally thought that the $33b Facebook valuation was ridiculous but am beginning to breathe the fumes. It is taking over the world. Set me straight please!

I responded:

Sounds pretty crazy to me. Might be based on a Gordon Growth Model-type valuation which #Refs out once the assumed growth exceeds the discount rate (which it almost assuredly would for Facebook). That said, these crazies don’t seem to think it’s so crazy.

Says he:

One of the commenters on that site has set me straight:

“Google provides a relevant service. FB is a spam hole. No one is going to pay for spam unless it’s from the guy at the other end of the ad stealing your credit card #. FB is worthless. And of that 1 billion (doubt it), they still owe around 150 million for financing servers and other things. If they had the funds, don;t you think they’d be smart enough to pay CASH, instead of paying interest on a LOAN?”

Insightful stuff. Shame on me.

So the answer for VCs is simple. The valuation is too hard so ignore it, but buy a portfolio of interesting businesses and hope that you get a few home runs. Oh, also sell some of your early shares in Facebook at that $33B valuation because you never know what lurks around the corner.

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FT.com’s Lex has an article (Sara Lee in play) on a possible bid for the food conglomerate Sara Lee (NYSE:SLE) by the old barbarians at the gates, Kohlberg Kravis Roberts:

Of course, a bid now might be opportunistic. Sara Lee has been without the architect of its restructuring since chief executive Brenda Barnes retired due to illness in August. Asset sales have brought debt down to moderate levels. And there is always a good price for a bad business. Sara Lee trades on about seven times prospective earnings before interest, tax, depreciation and amortisation – well below the double-digit multiples typical for attractive consumer goods acquisitions.

However, it is hard to see what might better be done with a collection of commoditised food businesses (bakery, meat processing and food service) and a low-growth coffee arm. Overall profitability has barely varied from a steady 8 per cent operating margin in two decades. Disposing of the North American bakery business, as management plans, should cause that to jump to 12 per cent, calculates CreditSights. But any sale also involves handing care of part of the Sara Lee brand to a third party, and buyers have not rushed to snap up an operation with expensive unionised labour. There seems little reason to linger at the gate.

I don’t think Lex will be buying the stock, but it’s still interesting. A portfolio of good brands with some commodity businesses thrown into the mix at ~7 times EBITDA. KKR could buy it, sell off the commodity businesses and do something with the brands (I don’t know, what am I, a PE guy?). It might be worth doing some work. Anybody got a buyout analysis they’d care to share?

No position.

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The inimitable Distressed Debt Investing has another great analysis of Visteon (see my post archive here). Hunter says:

In my 8 years on the buy side, in distressed and high yield land, I have never seen a more consensus long than Visteon’s when issued equity. Simply put, Visteon’s equity to distressed funds is like Apple to Long/Short funds. Many people I know are long it (including myself) – The only thing I can’t figure out: who is selling?

Here’s Hunter’s analysis:

  1. Visteon owns 70% of Halla: At the USD equivalent market cap of ~$2B, gives us $1.4B of value
  2. Visteon owns 50% of Yanfeng: We will use a 10x multiple, ~$900M of value [note I am seeing analysts put a 12-15x multiple on this business]
  3. Cash at Exit: $785M
  4. Added Cash from Warrents: ~$100M

That gets us to $3.2B before adding any value to the US operations. From this we subtract:

  1. Term Loan: $500m
  2. Cash at Halla ~$150M (as to not double count)

Which nets us to $2.55B of equity value. Still before US operations. 54M shares outstanding translates to $47/share. Given the $56/share price today, there is a $9/delta or $500M. This is where the market is currently valuing Visteon’s US operations.

And that’s where we say: “You’ve got to be kidding me?”

Everyone in the market knows Visteon sandbagged their numbers. Why? Because management is getting a good deal of equity post emergence. But let’s say they are right – the 2011 plan calls for $550M of EBITDA. You have to deduct Halla from this which nets you do approximately $300M.

Therefore the market is valuing the US operations at 1.7x. For a company with a net cash position…Here are some 2011E EV/EBITDA comps for your reference: TRW: 4.1x, LEA: 3.9x, Fed Mo: 5.0x, Dana: 3.9x, Tenneco: 4.9x. Let’s be conservative and use 4.0x and see where the value gets us to: Add $1.2B to our sum of parts above, gets us to a $70/stock. And I will tell you, I am probably one of the more conservative estimates out there.

I want to know who is selling this stock? Is this side as one-sided as I believe it to be (at $55/share)?

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Longterm Investing has a series of posts examining several scenarios in Seahawk (HAWK) following the recent conference call (see my post archive for the background). In particular, Neil has examined the effect of CEO Randy Stilley’s proposal to take on debt to buy rigs, rather than buyback stock. Here’s the analysis:

It’s important to understand how the risk-reward profile of HAWK is modified as they take on debt. In their quarterly call they indicated a strong preference for adding debt and adding rigs.

I’ve considered three scenarios.

1. HAWK retains their current leverage and uses asset sales to pay for operations. These asset sales will be at scrap values, around $7M per rig.

2. HAWK takes on 110M of debt and 50M of new assets. These new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is below the scrap value of existing rigs + new asset value.

3. Hawk takes on $150M of debt and 50M of new assets. Similarly,  these new assets are 3M cash flow positive each quarter after interest. All of HAWKs rigs, new and old are security for this debt. It replaces the existing credit line. This amount of debt is about the liquidation value of current rigs and new rigs, net of liabilities.

The “good case” is where HAWK continues their current cash burn, as modified in the scenarios above, until a point in time when rig market values return to December 2008 levels.

The company values under each scenario are shown below assuming a return to December 2008 values in that period. The value added and subtracted by debt are shown along with the 40M residual value under case 2.


See the post.

Long HAWK.

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Andrew Shapiro has talked to Seeking Alpha’s Jason Aycock about his single highest-conviction position, Reading International (RDI) (See the RDI post archive):

If you could only hold one stock position in your portfolio (long or short), what would it be?

Our best risk/reward idea is Reading International (RDI), an internationally diversified movie exhibitor, with a related business segment that owns, develops and operates substantial real estate assets, many of which are entertainment-themed retail centers (“ETRCs”) anchored by Reading’s cinema multiplexes. Reading’s cinemas generate growing, recession-resilient and recurring box office and concession cash flows. The cinema business builds value by paying down acquisition debt, as well as funding the front-end cash demands of developing Reading’s valuable real estate assets. The development process includes purchasing raw land, up-zoning, development and construction, eventually generating cash through leasing or outright sale.

In addition to its upside from present prices triggered by impending catalysts and growing cash flow, Reading has an enormous “margin of safety” both from the value of its huge landholdings in Australia, New Zealand and the United States, as well as a reasonable valuation of its cinema segment.

Tell us a little more about the company behind the stock.

Over the past few years, Reading has strategically expanded its many cinema circuits in Australia, New Zealand and the U.S. through organic growth and acquisitions, building the fourth-largest exhibitor in Australia, third-largest in New Zealand and the 12th-largest here in the United States. Its approximately 462 screens in 56 cinemas and four live (“Off-Broadway”) theaters are primarily situated on owned or long-term leased land.

Reading’s cinema segment cash flows have continued to show resiliency in recessionary times, producing approximately $35 million of adjusted EBITDA for the 12 months ended June 30. In addition to selective new theater openings and culling of underperforming theaters, Reading has begun equipping a majority of its theaters with digital 3-D capabilities that will provide incremental cash flow into this cinema segment.

As for the real estate segment: Unlike other cinema exhibitors, Reading owns over 16.5 million square feet of real estate, of which only 1.2 million square feet is already developed and generating approximately $13.5 million of adjusted EBITDA for the 12 months ended June 30. In many instances, Reading benefits by having its own multiplex as an anchor tenant and by having itself as landlord. Developed real estate includes the Courtenay Central shopping center in downtown Wellington, New Zealand; the Red Yard Centre in the Auburn suburb of Sydney; and the Reading Newmarket Centre near Brisbane, Australia.

A substantial portion of the more than 15.3 million square feet of additional land owned by Reading holds great cash flow growth potential as it is developable in desirable urbanized locations throughout Australia, New Zealand and the United States, but not yet generating a dime of cash flow. These undeveloped parcels are in various stages as stand-alone developments or “phase two” expansions of existing ETRCs. In addition, Reading owns the land underneath its New York City and Chicago live theaters, including the Union Square Theater, and also midtown Manhattan real estate underneath its Cinema 123 on Third Avenue, across from Bloomingdales – all prime land.

Reading’s 51-acre Burwood Square project in Melbourne, Australia, is by far Reading’s most valuable undeveloped parcel, on its balance sheet for around $45 million. Purchased in 1996 when it was a former brickworks and rock quarry, this giant parcel has now been upzoned to be a “major activity center,” zoned for residential, commercial, entertainment and retail use, and is one of the last prime developable sites fairly close to Melbourne’s central business district.

It should be noted that Reading owns its Burwood parcel (as well as its recently completed and leased Indooroopilly Brisbane office building) debt-free, unencumbered by any mortgages.

Most of Reading’s real estate that has been held or developed over a long period of time (some, like Burwood, since the mid-90s) is on the company’s balance sheet at values which we believe greatly understate current market value. These parcels have enjoyed – to varied degrees – substantial unrealized appreciation from up-zoning, surrounding population growth, property improvements, construction and lease-out, and, in some instances, more than a decade of market inflation.

As more of Reading’s real estate assets are converted to either current cash flow generation or outright sale, Reading ought to be viewed more and more as an undervalued growing operating company attracting a multiple, rather than simply an asset play.

How does your choice reflect your firm’s investment approach?

My firm, Lawndale Capital Management, and the funds it manages have for over 17 years targeted capital appreciation in securities where our research-intensive and active style can add value by identifying and capitalizing on market mispricing. We invest as very active owners, preferring to have strong friendly relationships with the portfolio company managements and boards, but never afraid to take any and all measures that are in the best interests of protecting and creating value, including proxy fights or other legal steps. We regularly take 13D filing-size positions and communicate our views.

We seek large returns through concentration in a few core companies that are analytically out-of-favor (contrarian), analytically complex (special situation), or analytically uneconomic (illiquid). We find small and micro-cap company stocks, and small issues of more senior securities such as preferred stock, and corporate debt of even larger companies, are often priced inefficiently due to illiquidity and investor neglect or incomplete fundamental analysis.

We balance our quest for substantial returns with a fundamental tangible asset-based and deep value-style approach, seeking a “margin of safety” that cushions the biggest risk to our returns: the extensive time and effort to unlock value in our portfolio companies.

Our Reading investment fits right in with our strategy. It started even more analytically illiquid and complex when initially invested in Reading’s three micro-cap predecessor companies, Craig Corp., Reading Entertainment and Citadel Holdings. These companies had much smaller public stock floats and an interrelated ownership structure confusing to most investors. We encouraged and supported a year-end 2001 merger of the three companies to become the single, simpler and larger small-cap Reading International. Even today, tracking progress milestones and estimating the value of Reading’s multiple undeveloped foreign parcels turns off most investors and every sell-side analyst. The fact that Reading’s current stock price basically provides its sizable undeveloped landholdings for free more than adequately provides us our required margin of safety.

How much is your selection based on the Reading’s industry, as opposed to a pure bottom-up pick?

The concentrated private-equity-like portfolio approach Lawndale takes creates inherently larger event risk, so we seek to invest as generalists in several different industries. That being said, as deep value balance sheet-focused investors, we have a predilection for companies with hard assets where investors aren’t pricing those hard assets. For example, with Reading, we own a sizable cinema player that owns a lot more land than investors give it credit for.

In general, our selections are bottom-up where we identify assets undervalued by the market due to perceptions or misperceptions of perpetual deterioration or perpetual stagnation at best. We look for operations that can be turned around, credit quality that can be improved, or dysfunctional boardroom and management situations that are fixable with a catalyst such as ourselves.

How is Reading positioned with regard to competitors?

Initially, the entrenched real estate moguls in Australia severely stalled Reading’s development plans in the late ’90s and early part of this decade, but that logjam has been overcome and almost all of Reading’s parcels have now received their up-zoning.

While Reading’s small theater footprint in the U.S., relative to Regal (RGC) and Cinemark (CNK), had hurt availability and terms on first-run films several years ago, an antitrust lawsuit against the largest movie studios and exhibitors (long since favorably settled) and growth of Reading’s market share in certain markets (70% Hawaii, 12% San Diego) has alleviated this issue.

How does Reading’s valuation compare to its competitors?

Extracting the value of all of Reading’s real estate from its enterprise value imputes a compelling, very low or even negative multiple on Reading’s geographically diverse cinema business. Alternatively, Reading’s cinema business, using multiples below those of comparables, plus its understated book value on its developed real estate, exceeds Reading’s present enterprise value. Thus, the value of all of Reading’s substantial to-be-developed real estate is “free,” serving as a substantial “margin of safety.”

Without individual cash flow figures available on Reading’s land, our valuation model becomes a three-pronged matrix. On the cinema segment, we use an EBITDA multiple as well as a multiple on-screen count. For developed parcels, we are compelled to use a multiple on net book value, based on building age and occupancy and/or appraisals the company previously disclosed. On the to-be-developed parcels we use very conservative assumptions in an NPV approach. Finally, while cinema segment G&A is accounted for in its EBITDA, including a deduction for the value of real estate segment and normalized corporate G&A expenses results in a total value range for RDI of at least $8-12/share. [Reading closed Wednesday at $4.32.]

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