Wednesday, September 30, 2009
At least for now. Our new proprietary 3-P Doomsday Index says so. The talented staff here at the world headquarters have labored tirelessly over the last few months and have come up with the Barbarian Capital 3-P Doomsday Index (TM).
3-P stands for Pasta, Pistols and Pawnshops. You know, the stuff you'd expect to go up as society disintegrates.
Let's look at the returns for the last 6 months:
American Italian Pasta Company (Nasdaq: AIPC): -20%
Smith & Wesson Holding Corp. (Nasdaq: SWHC): -15%
EZCORP, Inc. (Nasdaq: EZPW): +13%
H/T Gawker for the bunker food pic.
Monday, September 28, 2009
This longish story has popped on many "must read" links starting Sunday night. It is the uncovering of the guy who is the driving force behind Zero Hedge. I have been following ZH since the spring, and the blog is a standout among the 250+ subscriptions I have. Here is why:
(1) Written by plugged-in professionals
(2) A wealth of timely information
(3) Level of detail and intensity that is unmatched almost anywhere in the blogosphere (never mind the "traditional" media)
ZH has been attacked viciously by the mainstream because ZH to them is what a mammal is to a dinosaur (how's that for a SAT question?) It is simply a better model of (financial) media.
See, journalists for the most part are not experts at the subject matter they report on. The crisis has made that painfully obvious. Most seem innumerate and completely out of their depth when trying to grasp complex issues. It is not their fault: no one taught them those things in journalism school. Some of them, I am sure, went to journalism school to begin with because they did not have to do any math, let alone financial math. Mr. Gasparino may have spent three years reporting for The Bond Buyer but I somehow doubt he knows what bootstrapping a yield curve is.
The traditional journalistic model has been chasing a story, packaging it in the most sensationalistic way possible in order to up the ratings/sell copies, and moving on to the next story. The media outlets have been both the bottleneck and the toll collector for both news consumers and advertisers. What is happening now? The mammals are out and the dinosaurs do not like it at all. Neither does the government because "the message" and "the issues" cannot be controlled like they used to be. This is what now Congress is looking at bailing out the newspaper industry by granting it a tax-free (aka non-profit status that can later be used as a lever to control the message).
With blogging, everyone has a soapbox. This includes a number of professionals who understand their own subject matter much better than any journalist ever will. Consequently, more specialized topics are much better presented and discussed in the specialist forums, not in the mainstream. The traditional media model has neither the cadre nor the time and space for deeper thoughts.
Blogging, of course, is a true survival of the fittest. You do not have the licensing and frequency restrictions (for now) that traditional media has, nor the capital requirements. Therefore, a better product can do what House of Pain once sang about: "I'm the cream of the crop/I rise to the top." If there is no value to a certain blog, it simply won't get the traffic and publicity. ZH has done both: the results speak for themselves. There would not be ZH if what they wrote/write about is of no value to the readers. Do I agree with every post? Of course not: you cannot expect someone else to do your thinking instead of you. But the old media would have you believe so, and that is why they are grasping for every possible straw in their feeble attempts at attacking ZH's credibility.
ZH, and many other blogs, have honestly earned their credibility through professional competence while a "regular" talking head on CNBC will never even come close to it. We do not expect journalist to interpret medical studies' results and yet, some of them try (and often fail) to add "depth" to the discussions of complex financial issues. If one then adds commercial breaks and sound-bite oriented hosts, the one has to spend a lot of time in front of the screen to learn anything of value. By my estimation, Durden's raw IQ is at least 50 pts higher than that of any CNBC "personality."
Old media sees its grip slipping away, and is trying to both play by the new rules and to attack the "morons" that write blogs. Some bloggers with decent online rep have joined Reuters, for example. But old media is losing in the new landscape because there are no barriers to entry and news consumers can vote with their browsers quite easily. I canceled my WSJ subscription soon after I discovered Google reader. And I do not know if most old media journalists have the basic business wherewithal to understand the paradigm shift.
How can one play this? It's not a secret and it is probably priced in: NYT, WaPo, Gannett, Scripps, McClatchy are all publicly traded.
What may not be priced in is the view that timberland is a good inflation hedge: we might be having a qualitative change here that we have not had since Gutenberg so it may not work out as well this time around.
Update 1 9/30/09: Here's a blogger from Reuters with what sounds like a very, very acidic case of sour grapes. I would describe it as a rather unsophisticated attempt to disparage ZH's readers as"delusional" "angry" "have the hubris" "daytraders."
While I enjoy the author's usual fare and read 80%+ of his writings, I do think he lacks depth even in areas where he claims some expertise (i.e. sovereign bond defaults, the business of art, biking) and his claim to fame is nothing more than an attempt to simplify a rather complex phenomenon to mass-market levels. Even his unique topics, such as the Leibovitz loan or the Brandeis art collection scandal, have had all the sharpness of a gefilte fish.
Thursday, September 24, 2009
We have had deteriorating economic fundamentals for a while. The recession officially started in December of 2007, I think. The economic fundamentals- including too much debt- drove down equity prices quite a bit. It is not rare to see it called a "generational low."
Then, since March, we have had a huge run-up in prices (Fed pump discussions aside). Many companies, including the sickest of the sick, such as banks and REITs, jumped on the wagon and issued bucketloads of equity, and the new equity was often used to paid down debt.
What happened? The higher equity prices prompted new issuance which, in effect, led to a re-equitization, which de-risked the equity/improved the "fundamentals", making the equity potentially more valuable.
MTN has three lines of operations: mountain, real estate and lodging. The bulk of their business is the mountain/lodging segment: they run several high-end ski places, including the eponymous Colorado resort. I should also say that they are a well-run business, did not go crazy with leverage or real estate (unlike their competitor Intrawest), and have what I consider a decent moat. Most of their operations are on federal land and subject to numerous restrictions, which makes it harder for new entrants to compete. They have expanded into some summer businesses. In addition, they foresaw the slump and planned accordingly last fall. The company also does an excellent job in breaking out revenues and expenses by segment, as well as giving a lot of relevant metrics (# of visits; effective ticket prices; revenue per available room). They even report EBITDA by segment and give great updates on advance pass sales and the real estate pipeline, which is very helpful for an analyst. They have also been paying down debt diligently, which, in their case, is good news for the shareholders.
Now on to the bad part.
MTN operates a highly cyclical business: they are in high-end tourism. Ski vacations are pricey for Joe Sixpack even in the best of times. Last October I priced Christmas week in Vail (airline tix, rental car, hotel, ski rental, lift tix) vs. the same week on a mid-range, all-inclusive cruise out of Miami (again, with airline tix), and the ski vacation was 2x the price of the mid-range cruise. I know that they are not directly comparable but I think it provides a good guidepost.
On top, while Vail Resorts markets itself as a resort operator and all that, in fact, if you dig in the 10-K's you will find that MTN is primarily a LIFT operator. This is correct, the lift ticket business is the single most important business they have. It is a nice local monopoly in the whole area so long as there are people who want to ski. And the problem with the lift business is that you have to run the lifts whether you've got people or not. This is a huge fixed cost. To their credit, they have done their best to drive traffic by offering great deals on seasonal passes to ensure a level of revenues, and they have managed capex accordingly.
Let's look at valuation. Cyclical businesses generally have, you guessed it, cyclical earnings. This, in some cases, leads to cyclical multiples and, thus, cyclical valuations. One can make a killing both on the way up and the way down, with some timing luck. Look at the fertilizer companies as a good example.
MTN reported today for the FY and gave guidance for next year. Let's take a look:
FY 2006 NI: $46 mm
FY 2007 NI: $61 mm
FY 2008 NI: $103 mm
FY 2009 NI: $49 mm
FY 2010 guidance NI: $25-$35 mm
Market cap is about $1.30 bn (ignoring options, this is just a back-of-the-envelope calc). This implies FORWARD p/e of 37x-52x. Even Obama and Krugman admit that unemployment will linger for a while, and MTN thrives in a high consumer spend environment. They are 13x their very best year which may not come around for a while (nice boost from the 3rd home market and sub-5% unemployment).
The P/E numbers do not work out for me on the back of the envelope which means they probably won't work out in excel either.
Like they say, buyer beware.
Update 1 9/24/09: And from tomorrow's WSJ, comes this relevant piece: Marriott is halting all timeshare and luxe-res developments and taking a $760 mm writedown on what it has in progress. This is the real estate part of the business at MTN that I mentioned above. You can read in the 10-K about their projects, incl. a Ritz-branded residence project with part fractional ownership. "The pullback affects all three formats that Marriott sells under its Marriott and Ritz-Carlton brands: time-shares, fractional-ownership projects and luxury-residential projects. Marriott is permanently exiting development of luxury-residential projects, which are for-sale condominiums and penthouses that sit atop or adjacent to its hotels." Poof.
A quick check of Marriott's last Q shows that they have $2,001 mm of timeshare "inventory", Item 9. This is a near 40% write-off, if it came only from there.
MTN has $311 mm of "real estate held for sale or development" and is substantially less diversified and less widely marketed than Marriott's efforts. I do not remember them taking any charges on those assets. You do the math.
Update 2 9/26/2009: An Aspen hotel developer files for BK. Note the super-tricky land use situation: something I mention above as a barrier to entry.
Update 3 10/07/2009: B of A upgrades MTN, price target of $37. Stock is up to $34. Clearly, not my view.
Tuesday, September 22, 2009
In what may turn out to be one of the least prescient calls of the crisis, on March 10th of this year, MCO publicized widely its Q1 "Bottom Rung": a list of about 300 companies at greatest risk of default. It happened to coincide roughly with Nouriel Roubini's World Victory Lap, and the 666 S&P reading. Back then, I created a portfolio with all publicly listed equities on Moody's list. Since equity has a residual claim, one would have thought that if the debt is rated as super risky, then the equities listed would be, in most cases, the casualties of the crisis.
It turns out that thinking contrarian on this occasion would have paid off handsomely to the person with the intestinal fortitude to do it. The mean return for these publicly traded equities since then is over 250%, with the median at 150%. There are some real stars, like American Axle, Dana or LodgeNet, clocking in at over 1,000%.
One can look a the results two ways. One way is along the lines of "in March, those shares were simply options, and they delivered an option-like return", "absolute junk rally", "high beta outperformed on the way up as it underperformed on the way down", "most were down 80-90% so they bounced back some", etc. The second way is the Jesse Livermore way: take a step back and agree that these stocks were simply on the "right" side of the market without digging for a fundamental reason: it is what it is. "Old" GM is still worth north of $600 mm. It makes no sense whatsoever from a fundamental perspective, you can read it loud and clear on the Motors Liquidation Company web site (the site itself is akin to a forgotten tombstone of a once-great).
Please note that the majority (~2/3rds) of the companies on MCO's list are private, so the results may not be representative of the whole group. In addition, many of these equities trade OTC and were/are valued at well under $1, which makes them unsuitable for most investors.
Interestingly, Moody's has not made an effort to publicize their bottom rung list for the next two quarters, which makes me think that the findings in this post are on to something. For more on MCO, I highly recommend Einhorn's earlier speech (.pdf) and more recent interview on CNBC. Of course, he is talking his book but one can discern how reasonable he is, and then decide on how to proceed. His issue is with the fallout from the wrong AAA but assuming- safely, I might add- that the debt on the bottom rung delivered returns that are even 1/4 of the equity returns, then there is a problem with the CCC/under, as well (Caa, to be technically accurate). And, unlike the AAA structured products where there has not been real history to look at, all these are "regular" operating businesses, which have been the bread-and-butter for the rating agencies on the corporate side.
Please note that the work is not warrantied. I did it for my own information.
Update 9/23/09: ZeroHedge today seems to be on the same conclusion with a more substantive screen.
Update 2 9/23/09: Now Clusterstock has an interview with a former high-ranked insider from MCO who suggests that the company should be liquidates. "Asked about why Moody’s-–which has come increasingly under fire in recent weeks--is still in business, Raynes says: "It’s like prostitution. It’s a crime but it's feeding a need."" Nice, huh? Echoes Barry Ritholtz's thesis from back when. McGraw-Hill (parent of S&P) even refused to print his book.
Moodys Q1 2009 Bottom Rung
Wednesday, September 9, 2009
(1) KFT is offering currently 12x CBY's 2009E EBITDA. This is a very rich multiple even if you factor in the mythical "synergies" they claim are achievable. The market expects that the multiple will go up which is, again, bad news for KFT shareholders. "Synergies" are pretty dangerous: there is no way to track those once the deal closes. KFT in the letter says that the footprints are complementary. You cannot have complementary product and geographic footprints AND substantial synergies. Expect to see massive baths in Q1-Q2 after the close for "integration costs" and related. Nothing gooses EPS better than big, fat write-downs.
(2) KFT does not appear to be a "best in breed" business. There are many reasons for this but it is evidenced by the fact that the share price is 13%+ lower today vs. the price at which they went public in....2001 (total return might be slightly positive with dividends). Also management has faced criticisms regarding their turnaround plan. They even had to put it verbatim on a presentation slide that "our plan is working". If it really were, you would not have to write it down.
(3) KFT seems dead-set on completing the acquisition. This is a very poor negotiation stance which will hurt the KFT shareholders as KFT will likely overpay. I found it astounding that they would communicate that so clearly. Since KFT management is not dumb, it makes me wonder if the whole acquisition is an attempt to both distract from KFT's performance and roll the dice with a large acquisition.
Call me paranoid, but remember that management has options which incentivize them to act imprudently (from a food co. shareholder point of view) and seek volatility. KFT is overly reliant on low value-add generic categories in the US (cheese, mayo, dressings) so their performance recently has not been great as private label takes share there easily, so let's invade Iraq.
(4) KFT has also explicitly committed to maintaining IG. They are currently at Baa2 and already have $18 bn +/- of debt on EBITDA of $5ish. A CBY deal would likely be at around $18-19 bn EV with a best-case EBITDA of $1.5. Assuming that the current 3.5x is the IG threshold, even call it 4.0x, this implies that CBY can carry $6 bn in debt. They have to refi $1.5bn, leaving them down to $4.5bn in new debt. This means $15 bn of new KFT equity, on a current market cap of under $40 bn.
Now, they still have a notch down to go on the IG scale. Assume that 4.0x is the limit there. The combined company could then potentially carry $7.5bn x 4.0 = $30bn in debt. This still implies $7-9 bn in new KFT equity.
In other words, dilution is coming.
Update: Well, this was quick. "Kraft Foods Inc... is in talks to arrange about $8 billion of financing for the bid, Bloomberg said..." So, if closing EV is $18 bn, you're looking at $10bn of new equity. Short-term currency trends are not favoring KFT, either...
Update 2 9/11/2009: Here is a great post on why the offer price makes no sense. I am not familiar with their MVIC metric, I do not agree with their delevering paragraph for the most part (yes, KFT is aggressive with debt) and I am not sure how they figure out what CBY's growth and margins ought to be in order to "justify" the current purchase price. They also do not adjust for the DPSG spin-off, pretty typical of generalist finance types.
I just looked at it from an EBITDA basis, and thought the bid was high. CBY hit a low of under $28 in March, and is now at $51. Does KFT really believe that CBY is now 80%+ more valuable than it was 6 months ago? Just asking.
Update 3 9/16/2009: Now there are reports that Kraft will be selling assets, such as Maxwell House and Oscar Mayer to pay for the acquisition. Again, this is poor negotiating: the buyers will clearly know that KFT has boxed itself in and needs to sell. This is not a way to deliver value to the shareholders. Now, the coffee asset is interesting, if one looks at the wonders Folgers is doing for JM Smucker (SJM): three-four quarters of blowing past expectations. Coffee has been on a roll for the last year or so (see GMCR and, more striking, DDRX) with both increased store traffic/at-home-coffee and the success of the k-cup systems. I do not know how much Maxwell House has benefited from this, may be they are the big loser there. It is hard to tell without fresh Nielsens. Oscar Meyer is closer to a non-brand in my view. Sara Lee (SLE) would be a good buyer but the combined share might be too big. Smithfield (SFD) recently communicated that they want to move more into packaged foods but I do not know how much they can afford it.
Update 4 9/21/09: Cadbury is doing what they are supposed to do, which is act tough to get. Just like early-stage dating: don't seem too interested. I think a deal will happen, KFT will likely raise its price to the further detriment of its shareholders, and CBY's board will "unanimously approve" the new offer. There are no indications of a serious white knight bid from HSY, either. They have not retained what I'd call "conventional" advisers. One is a PE shop, run by a former banker (possible coinvestment?) and the other one is a small boutique called Watch Hill. One would think that there would be at least one adviser with a balance sheet.
Update 5 9/23/09: I just made the parallel to dating two days ago, and now ResearchRecap is saying that KFT and CBY are circling the dance floor. I can even hear ABBA's "Dancing Queen" in the background. In what should put to sleep any doubts about this deal happening, CBY's CEO Mr. Stitzer even named his price: 15x. Ok, basic negotiations, you ask for more than you expect to get. The question now is whether the deal happens at 13x or 14x, and at what cash/equity split. I can already see the teary-eyed joint press conference with the two outsized logos in the back, the talk about the new and exciting future, the cornucopia of free snacks for the press corps in the back, someone mentioning that Milka's and Dairy Milk's brand colors are so close that the merger was meant to be, etc. I think I will layoff following this deal now unless something substantial emerges.
Update 6 9/27/09: I was just thinking that this will be quiet for a while. But both management teams seem to have been on a sugar high. First, we had reports denying that Cadbury has said what it would sell for. Ok. "CEO Todd Stitzer said on Friday he did not believe Kraft's offer for the company made strategic sense, as he tried to clarify remarks he made that drew scrutiny from Britain's Takeover Panel." His original remarks: "Stitzer was quoted as saying Kraft's 10 billion pound ($16 billion) bid made some strategic sense." Confused already?
And this morning, the more interesting news come out, Kraft might go hostile. I would like to assure you that hostile bids are bad news for the buying shareholders. There is no such thing as hostile: it is all a matter of price. With CBY's stock now probably largely held by arbs, you can bet that they will try to squeeze every triscuit from KFT. That's what they do for a living. And, there even isn't a credible white knight bid. My original thesis stands: this merger is bad news for KFT shareholders. If new facts emerge (or I bother to read up), I may change my mind.
Update 7 9/30/09: How did I get stuck with this job? Again, I was thinking I'd lay this deal off for a bit, and, again, developments show up. First, CNBC is reporting that the WSJ is reporting that HSY "remains stymied in its ability to assemble a takeover offer...so far have no financing or strategic plan for a bid...realized it is several billion short of matching the current offer..." Just as I suggested in Update 4 above. Also Nestle yesterday mentioned something about their focus on wellness "as it seeks higher margin businesses": in my view their CEO is signaling to the market that Nestle will not be chasing CBY.
Also, the UK is telling KFT to make an actual offer by November. Mrs. Rosenfeld's letter, if you remember, said that it is not an offer (under something like "for further avoidance of doubt").
Update 8 11/3/09: Finally some substantial news ahead of the deadline. Reuters is reporting that KFT has secured a $9 bn bridge, as UK regulations require that KFT show that it has the financing. In the article, some analysts are saying that KFT will sweeten the offer, while "people familiar with the situation" are saying that it won't. From a KFT shareholder perspective, I hope they stay put. Their shares tanked 3% after-hours on the earnings report, and are now $26.70, roughly in range of where they have been trading post-offer.
Saturday, September 5, 2009
I did not think this was going to happen but we finally have the first bona fide attempt by the current US government to encourage savings. Unless you have not been in the country, every other government initiative has been designed to discourage savings: homebuyer credit, appliance credit, car credit, on top of a non-stop government borrowing and spending. This, of course, is not the way to go.
The new proposals are very weak but I find them encouraging as they are finally a step in the right direction. They are:
- Easier automatic enrollment in 401(k) programs
- Easier automatic contribution increases in those
- Option to get the tax return as a savings bond
- Option to direct unused vacation pay upon termination into a savings plan
These are minuscule steps in the right direction. My proposals (not that I am running for office) are more substantial:
- Credibly engage in an honest money policy as inflation discourages savings
- Raise interest rates to a point where there is actually an incentive to save
- Go all the way, repeal the income tax and introduce a national sales tax
- Cancel all spending subsidies immediately, including mortgage interest deductions
- Double the 401(k) limits and make the IRA limits equal to the 401(k) limits
- Do away with income limits on tax-advantaged plans
- Mandatory automatic enrollment in a LifeCycle-type fund
- Lower 401(k) and IRA fees across the board (i.e. close to matching Vangurad's mutual fund expense ratios)
- Mandatory trailing stop-loss orders on all equity funds in retirement accounts
There are many more things but these are my major ideas. I think the savings bond tax return will be a fail because people often count on the "check" to make ends meet, and US savings bonds pay pitiful interest.
I commented earlier on Obama's disastrous personal finances. Here is a good run-down. Both are out-of-control spenders making over $250k regularly, and yet having practically no interest income. Constant refinancings helped them spend $80k more than they made by these estimates, until the book royalties kick in and Michelle gets a super-important, high-paying job that is then eliminated once she leaves. In addition, I do think Obama is innumerate - like most elected representatives- as I shared in the same entry. Here is a quote illustrating this from the NYDN article:
"Obama did make a feeble attempt to control spending when he announced that his cabinet had found ways to reduce federal spending by $100 million. But this is laughable. Compared to an estimated $3.6 trillion federal budget, it is a minuscule 0.0028%.
To put this into the context of the Obamas' income for 2004 of $207,647, this savings works out to $5.77, or about the price of an arugula salad."
Emphasis mine. So, in my view, POTUS is both innumerate and does not value savings; consequently we have multi-trillion dollars deficits as far as the eye can see and weak proposals to encourage savings.
Thursday, September 3, 2009
Two, it is one of the least adulterated business activity stats that are available out there. It is unfortunate that the nation's largest retailer stopped reporting them monthly earlier this year just as theirs started turning negative. Surely a pure coincidence.
Retailers in September will start to lap some of their toughest comps vs. last year, and I think how the SSS come in September, October, November and December will be a good indicator of what is actually happening on the consumer side of the economy (widely estimated to be at ~70% of GDP). The bottom started falling off for many mid-priced retailers in the fall, and I would be concerned if we keep seeing double-digit decreases. Luxury retail started sinking on a SSS basis earlier on '08 and most, it seems, are past their worst SSS declines (i.e. Saks, Nieman are no longer at negative 25%+ comp).
Of course, SSS is just one piece of information in the paysage. A sale does not mean a profitable sale, let alone a sale profitable enough to earn a proper return on capital. Retail sales figures can be inflated by running major sales events that can be disastrous in many ways: not earning a good return on capital, pulling demand forward and damaging the brand equity. On the other hand, retail sales are almost always "real": the cash actually changes hands. There are very few retailers (Target, Nordstrom) that still have credit risk because of they have their own credit card operations; most others have farmed out the branded credit cards to the likes of GE Consumer Finance, BofA and JPM Chase. Retailers cannot engage in "stuffing" the channel, "bill and hold" and other tricks.
More specifically, looking at the data that came out over the last two days, I can see that in apparel/department only ARO, BKE, ROSS, TJX and CTR are positive, while all others are negative. Leading the way, ANF- everyone's a hater now- with a drop of 29% and APP accelerating down to 20%. Have both lost their cool? May be.
What is more interesting, August is back to school month, and with all the sales incentives going on (discounts, sales tax holidays, and such), the picture is largely negative. This is not an encouraging sign for the green shoots believers. And the unemployment data keeps getting revised unfavorably. There is also an interesting story about layaways at KMart with...back to school supplies. The big three in the office space (SPLS, OMX and ODP) do not report monthly as far as I know.
No wonder we're in this state of affairs.