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

Magic Formula

June 23, 2008

I have posted before about Magic Formula investing, with the help of Digital Look I have prepared a table of magic formula type shares in the UK.

I ranked companies by their ROCE, then by P/E, then combined the ranks giving a high rank to those with both a high ROCE and a low P/E.

The top 19 companies are:

Company ROCE P/E
Sport Media Group 129.06% 2
New Star Asset Management Group 290.10% 2.8
Charlemagne Capital 122.89% 3.3
Creston 107.44% 3
Synarbor 84.54% 2.2
Jacques Vert 108.37% 3.4
RDF Group 81.49% 2.5
Garner 483.33% 4.4
Yell Group 70.85% 2.3
Belgravium Technologies 125.06% 3.9
Somero Enterprises (Reg S) 86.60% 3.5
OPD Group 118.41% 4.1
Lincat Group 82.95% 3.6
Litcomp 79.18% 3.6
Celtic 68.53% 3.2
Castle Support Services 86.39% 4.1
Topps Tiles 82.28% 4.6
Solid State 75.17% 4.4
Avingtrans 75.09% 4.4

A Thought About Valuation and Multiples

April 16, 2008

A multiple is just someone else’s discounted cash flow – with all the messy maths and assumptions hidden behind a single number.

Market multiples (be it a price earnings, revenue or EBIT multiple) are just single number that hides the assumptions the market is making about that company’s expected future cash flow (and the level of risk associated with that cash flow).

Transaction multiples just hide the acquirers assumptions around the expected cash the asset will produce under their ownership / capital structure / management etc.

Berkshire Hathaway

April 16, 2008

Few highlights from Berkshire Hathaway’s 2007 annual report.

Charlie and I look for companies that have:

  • a business we understand
  • favorable long-term economics
  • able and trustworthy management; and
  • a sensible price tag.

A truly great business must have an enduring “moat” that protects excellent returns on invested capital.

But if a business requires a superstar to produce great results, the business itself cannot be deemed great.

There’s no rule that you have to invest money where you’ve earned it. Indeed, it’s often a mistake to do so.

[Talking about investments in different types of companies] To sum up, think of three types of “savings accounts.” The great one pays an extraordinarily high interest rate that will rise as the years pass. The good one pays an attractive rate of interest that will be earned also on deposits that are added. Finally, the gruesome account both pays an inadequate interest rate and requires you to keep adding money at those disappointing returns.

[On buying Dexter, a shoe business with Berkshire stock] In essence, I gave away 1.6% of a wonderful business – one now valued at $220 billion – to buy a worthless business.

[On buying Amazon bonds at 57% of par] Yes, Virginia, you can occasionally find markets that are ridiculously inefficient – or at least you can find them anywhere except at the finance departments of some leading business schools.

Cameron Partners

December 4, 2007

Just came across the Cameron Partners website . The part that caught my attention was the news section with a series of presentations. The most recent is Food Industry Acquisitions Set to Continue, by Hugh Cotterill – November 2007 (pdf).

While Premia in New Zealand Takeover & Offer Proposals, by Paul Dougherty and Stephen Kaiser – October 2007 (pdf) states the median premium for control (think take over premium, or the extra price paid when someone looks to acquire a listed company) in New Zealand (whether successful or unsuccessful) is 23.6%.

Which leads nicely to another article titled Boards Should Act on Control Premiums, NBR 28 April 2006 , by Paul Dougherty (pdf). This explains the premium for control exists if someone thinks they can extract more value from the set of assets owned by the company with the current business plan and/or management team .

The two main sources of this extra value are stand-alone improvements (cost cutting, growing existing revenue, new products, asset sales or new technology) or synergies (typically cost savings from combining the business with another entity).

The business can have a different value to the purchaser with access to these gains than the existing shareholders with the current management team and business plan.

The article goes on to say a number of advisers suggest there is only one true or “fair” value for a company. While value is in fact different for different owners, depending on the improvements or synergies they can achieve.

Important Variables

August 22, 2007

Interesting post at Gurufocus.com about important variables in valuation, including perhaps how Warren Buffett looked at his orginal investment in Coke.

“There are an infinite number of facts that you can learn about a company, but there are usually two or three very important variables that make the company succeed or fail. A lot of Wall Street gets so bogged down in the minutiae and details that it misses these two or three big things that make or break the investment. Part of what worked for me over the years is being able to distinguish what matters from what doesn’t. That’s one of Buffett’s great gifts. He focuses on the critical issues involved in analyzing. I don’t pretend to be able to do it like he does but it’s one of the most important things you can do.” – Wallace Weitz

When Buffett looked at Coca-Cola he was probably looking at the total servings sold per annum and the profit per serving of each Coke. Those are Coke’s key variables, the number of servings people consume and the profit per serving for Coke products. Buffett was certain that consumption would increase through taking share of other liquids consumed. As well, he figured they could squeeze more than a penny per serving, which they were earning out of the product over time.

Morningstar Investment Methodology

July 27, 2007

On looking around Morningstar’s website I came across two documents, Morningstar’s approach to equity research and their equity research methodology. They offer a great overview of how Morningstar think about company valuation and market prices.

Here is a quote from the start the document about equity research:

At Morningstar, we evaluate stocks as pieces of a business, not as pieces of paper. We think that purchasing shares of superior businesses at discounts to their intrinsic value and allowing them to compound their value over long periods of time is the surest way to create wealth in the stock market.

Key topics covered include:

  • Economic Moat
  • Discounted Cash Flow
  • Discount Rate
  • Fair Value
  • Business Risk
  • Margin of Safety
  • Consider Buying/Consider Selling
  • Stewardship Grades