Punch Taverns

October 7, 2008

Excerpt from Greenlight Capital’s recent letter to investors which talks about Punch Taverns (PUB).

PUB is an operator and lessor of over 8,000 pubs in the United Kingdom. Approximately 875 are owned and operated, and 7,500 are leased to live-in long term lessors. PUB charges “dry rent” equal to 50% of the estimated 5-year average of pre-rent profits and “wet rent” of markup In beer. Lessors are required to buy all their beer from PUB, which PUB sells at a markup, acting as a distributor from the brewers. U.K. pubs are suffering from the initiation of the U.K. wide smoking ban, supermarkets’ aggressive beer discounting, and the U.K. consumer crunch. We believe the franchise model creates high margin revenues with low volatility. In addition, it appears the stock is under pressure because the market misunderstands PUBs debt structure. PUB has three debt securitizations, each structured to pay down incrementally between now and 2036 without needing to be refinanced. In addition, PUB has £283 million of convertible debt at the parent company due December 2010. During the quarter, the market began pricing in a high risk of default or cash trapping within the securitizations. In addition, PUB announced its intention not to pay a final dividend for fiscal year 2008 to conserve cash at the parent company. The market took PUB’s conservatism as a sign of potential cash flow problems regarding the debt and began pricing in an equity issuance to pay down the convertibles. Based on conversations with the company and analysis of the debt documents, Greenlight believes PUB has the flexibility to manage its securitizations without a liquidity crunch, even in a difficult period for pubs. PUB is likely to use the cash savings from the cancelled dividend to pay down some of its debt early. We do not think the chances of an equity issuance are high. Greenlight initiated the position at £2.83 or less than 4x estimated 2008 profits. PUB shares ended the quarter at £1.32 (you do the multiple).

Valuecruncher seems to agree putting a valuation of £5.25 / share on the PUB


Dr Pepper Spinoff

October 7, 2008

Excerpt from Greenlight Capital’s recent letter to investors which talks about the Dr Pepper (DPS) spinoff.

DPS was spun off from U.K. based Cadbury PLC in May 2008. The Partnerships established their position at an average price of $23.84, which represents 12x estimated 2008 earnings. DPS exhibited many of the characteristics we have seen in successful spinoff investments, including favorable management incentives (which were struck while market participants were still wondering how bad the company’s initial outlook might be in the difficult industry environment), systematic selling by U.K. shareholders more interested in the global confectionary business and less so in the U.S. beverage business, and a conservative management posture. DPS is the third largest liquid refreshment beverage company in the Americas, with a portfolio of 50 brands including Dr. Pepper, Canada Dry, 7-Up and Snapple. The company is a combination of a high-margin concentrate business (like Coke and Pepsi, which trade at 17x earnings) and lower-margin and more capital-intensive bottling and distribution operations (like Coca Cola Enterprises and Pepsi Bottling Group, which trade at 12x earnings). While the market seems to apply a discount for its bottling ownership, we believe that an integrated model affords DPS the opportunity to expand distribution of its underrepresented and newly-launched brands. Over time, DPS has the potential to generate meaningful earnings growth through new product extensions, increased use of its distribution capacity, further cost reduction, and increased exposure to single serve channels, where it is currently underrepresented. DPS shares ended the quarter at $26.48.

Other bloggers have posted on the DPS spinoff previously:

Gurufocus (which tracks investments by funds) points out that Greenlight have invested 6% of their fund in DPS.

Brinks Spin Off

September 16, 2008

Margin of Safety has a post about the spin off of the home security business from Brinks.

Brinks Co. (NYSE: BCO) has been the recent recipient of much attention from the hedge fund activists including Pirate Capital and MMI Investments which have taken sizable positions in the company. Pirate’s founder eventually got his way and was given a seat on the Board. Since then this one seems to be flying under the radar a bit. Meanwhile, the folks at MMI have been kind enough to share their diligence with us. A bit of sleuthing on the SEC web site and you will come across a set of slides filed by MMI laying out various scenarios under which Brinks management would be able to increase shareholder value.

Slides from MMI.

The post was in April 2007, but the spin off is now scheduled to happen at the end of October.


July 21, 2008

Valuecruncher has valued MSFT at US$33 a share, compared to the current price of US$26 a share.

Valuecruncher points out that:

The Client (Windows), Server and Tools (enterprise solutions) and MBD (Office) divisions drive 83% of revenues and over 100% of operating profits (the On-line Services and Entertainment divisions are still operating at a loss).

The point reminded me of this speech (pdf) by David Einhorn of Greenlight Capital. Basically he says the market is undervaluing MSFT by not recognising the value of the core business (Windows, enterprise solutions and office), while punishing MSFT for the divisions that are losing money.

He argues that the core business deserves a higher multiple, while the money losing divisions will not burn cash indefinitely. And goes on to outline the other potential options embedded in the company, like Windows mobile. He also notes that MSFT need to take on some debt and return cash to shareholders. Of course the Yahoo transaction could interfere with this, but overall it seems pretty sensible.

Here are a few quotes from the speech (pdf):

If I strip out these unprofitable segments from the consolidated numbers, Microsoft trades at 9x EBIT and 13.5x P/E (on adjusted fiscal 2007 estimates). Chemical Companies, Farm Equipment Companies and Railroads trade at higher multiples than this at the top of their cycles. Even Supermarkets trade higher than this.

I am not a techie and I am not going to outline how Microsoft is going to compete and win in every area they have targeted…. But I do know that Microsoft has invested and is continuing to invest over $6 billion a year in these things. This investment penalizes operating earnings every quarter. I believe that the current value of Microsoft shares implies that these investments are value destroyers. With Microsoft’s history, I am willing to take the other side of that bet without a PhD.

If Microsoft took the part of its mission to work for shareholders seriously it would optimize its cost of capital. Instead of $35 billion of cash it should hold perhaps $40 billion of debt or 2 times EBIT. This sort of recapitalization would return one third of the market capitalization to shareholders through dividends or buybacks.

As of 31 March 2008, Greenlight Capital held a US$387m position in MSFT, the second biggest position in their fund behind TGT. If you do a search for Greenlight Capital under Institutional Holdings on NASDAQ.com you can see all the holdings in Greenlight’s US$2.6bn portfolio.

Interesting Links

June 12, 2008

2008 Berkshire Hathaway Shareholder Meeting: Detailed Notes

May 7, 2008

Reflections on Value Investing has posted some notes from the recent Berkshire Hathaway meeting. Below are some quotes that I noticed.

I started investing when I was 11. I believe in reading everything in sight. I wandered for 8 yrs with technical analysis. I read Intelligent Investor, chapters 8 and 20 I recommend, and if you absorb it you won’t be a lemming.

Our job is not to select great managers, our job is to retain them.

In business school the amount of time spent teaching option pricing is total nonsense. You only need 2 courses, how to value a business and how to think about stock market fluctuations.

We never want to trade reputation for money.

There is a lot I wouldn’t buy even if best management in world, as it doesn’t make much difference in a bad business.

We want a company with durable advantage, which we understand, can trust management, at a good price.

If I were working with small sums of money, it would open up thousands of possibilities. We found very mispriced bonds. We found them in Korea a few years ago. You made big returns but had to be small size. I wouldn’t be in currencies with small amount of money. I had a friend who used to buy tax liens. I’d look in small stocks or specialized bonds.

Several times I have had 75% of my non-Berkshire net worth in a situation. You will see things where it would be a mistake not to act. You won’t see them often, and the press and your friends won’t be talking about them.

We have lower due diligence expenses than anyone in America. I know of a place that pays over US$200m to its accountants every year, and I know we are safer because we think like engineers – we want margins of reliability.

A brand is a promise.

We waste a lot of time, but we waste it on things we want to waste it on.

Investment Portfolio

April 21, 2008

Readers of this blog may be familiar with, blogs like ControlledGreed.com, Gannon on Investing, Value Investing, and a Few Cigar Butts and Value Discipline.

I intend to follow their lead and start posting about potential investments. And keep track of the resulting portfolio.

The portfolio will be highly concentrated, following the example of Mohnish Parbrai with ten positions each making up roughly 10% of the portfolio.

Companies I am looking at include:

Sears – SHLD:

Winn Dixe – WINN

EchoStar – SATS

  • Spin-off from EchoStar Communications (which has Bruce Berkowitz as an investor). The business makes set-top boxes for subscription TV, has seven satellites and US$1bn in cash.
  • The idea came from a write up by vinlin1060 at Value Investor Club, which I was able to read with a free guest membership that lets you view posts more than 45 days old.

Office Depot – ODP