Friday, May 8, 2015

Enterprise Group, Inc - Exit

The Board of Enterprise would like to re-price management's option grants at a lower strike price. 
 
A reasonable person could link this development with last quarter's earnings miss. 

Investing in this company's stock was my mistake, not theirs. They are who they are and I should have known better

In any case, I no longer have any confidence that the earning power of the business will overwhelm the risk of entrusting my capital to these people.

62 comments:

  1. Any lessons here?

    To me it seems the original discount to book value was not large enough for a business with not much of a moat. Seems to me that it is better to be too picky then to miss out.

    And adding when there was some doubt on CEO was a bad idea. Since i basically shadowed you in this thing.

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  2. There's not much wrong with the business as such and nothing wrong with the price paid for the business. If there had been, I wouldn't have given this thing a second thought.

    The first problem is that I pushed past my reservations about management (and about the Canadian newsletter complex).

    Why?
    Because the easiest way for management to enrich themselves would have been to
    -- set reasonable guidance;
    -- meet those parts of the guidance that are within their control;
    -- enjoy an EBITDA multiple in line with peers and use options proceeds to fund their lifestyle; and
    -- sell out at 7x when the market recovers.


    That's $20MM in compensation for each of these two jokers from simply doing the right thing.

    Then

    -- start another company and wash, rinse, repeat.

    Not only is it the most reasonable course of action but,in the context we're talking about here -- their past careers, their apparent preexisting reputations, and their likely future need for institutional money for future -- it is probably the ONLY reasonable course of action.

    On the other hand the best predictor of future behavior is past behavior.

    --

    The more important lesson for me personally is to not blog about stock about which I have some small feelings of discomfort, whether I buy/own them or not. I should simply place them alongside BFCF and LRT in the basket/trade half of the tracking portfolio.

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  3. If oil prices had stayed steady from the original thesis (or appreciated--which was not unlikely), and management had come close to delivering on guidance (no way for a shareholder to know they were going to miss), the math was there, the thesis was sound, and we all would have waked away richer.

    I do not believe there was a clear way to know that the character of management was less than desirable. Jaroszuk was previously involved in a bankruptcy. That doesn't not make him morally evil.

    I think we got unlucky. I don't think I would have done things much differently given the information I had at the time.

    Now it is a personal decision: do you hold and price in 5% dilution per year and a multiple poor management deserves, or sell because you distrust management on multiple levels.

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  4. Actually I'd like to push back a little against the "if oil prices had stayed constant" part.

    A reasonable investment idea of the stock picking (as opposed to the statistical) variety should be able to withstand sensitivity analysis that includes a poor operating environment -- a sudden and permanent fall in oil price, for example.

    If that were not so I'd have owned shares in Awilco.

    In this case, the properties of the business were such that the price paid was fair value for a poor operating environment and
    very good value in the operating environment that existed at the time.

    The problem, as you say and imply. is that one needs either

    1) a reasonable multiple to attach to the cash flows generated by the business; or

    2) a sale of the business outright; or

    3) some form of on-going payouts (preferably cash dividends)

    in order to realize the value of one's investments.

    And that sets up the dilemma that you have outlined. Does one hold on, just as the valiant shareholders in Korean chaebols and Japanese net-nets do? Or does one move on?

    And,as you also say, that's a decision best made according to one's circumstances and judgment.

    On the face of it the math suggests that holding on will eventually pay off well whether or not oil prices recover to their former levels.

    But here's something to ponder:

    Why don't these two fellows buy back stock?

    That would have a bigger impact on their wealth -- via (reduced share count) x (expanded multiple) -- than would re-pricing their options. And that's quite aside from the ancillary benefits that attend honourable behaviour.

    The risk here is that their next move, after having re-priced the options will be to take the company private at an unfair multiple.

    All of this could be moot, of course, if next week's sees earnings ahead of expectations and the stock re-rates. But I, personally, have had enough.

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  5. This comment is related to the post you linked to, although I guess it's also somewhat relevant here...

    Can we shoot the consultant that first uttered the phrase, "this award/grant/etc aligns management's interests with all shareholders by providing an incencentive to maximize long-term shareholder value"?

    Is the fact that you're paid millions to do your job not alignment enough?

    And if I hear one more CEO talk about "maximizing long term shareholder value", I'm going to lose it. For supposedly being so smart and so well compensated, it's amazing that most CEOs are just well-trained parrots.

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  6. Well that is dissapointing. Utilities performed poor as well. Did they buy a bunch of duds?

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  7. They didn't acquire businesses for U&I.

    The issue is the multiple. You'll notice that mgmt fees have gone up, options grants have gone up, that fellow Manu has resigned from Board of Samoth and now E. Etc

    It's about the multiple. They have lost the trust of the market. Maybe the market will prove to have a short memory but maybe it won't.

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  8. Did you look at Weight Watchers recent announcement that they are doing the same after the stock losing more than half of its value and management showing no ability to stabilize falling meeting attendances?

    From the recent proxy statement:

    We have issued stock options under the 2014 Plan and our other equity incentive compensation plans as a means of attracting, motivating and retaining employees over time to promote the Company’s long-term financial and strategic success. In addition, stock options also align compensation directly with the creation of shareholder value. Our Board of Directors has determined that certain of our employees have outstanding stock options with exercise prices and stock price performance vesting hurdles (such options defined hereafter as T&P Options) that are significantly higher than the current market price of our Common Stock. For a description of the T&P Options, see “Compensation Discussion and Analysis—Determination of Executive Compensation—Long-Term Equity Incentive Compensation—Types of Awards—Special Awards”. As a result, these stock options have little or no current value as an incentive to retain and motivate our employees.

    As a result, our Board of Directors has determined that it would be in the best interests of the Company and its shareholders to amend the 2014 Plan to allow us to authorize and conduct an Option Exchange, under which the Company would offer eligible employees the opportunity to exchange certain eligible T&P Options on a (a) two-for-one basis for new stock options for all eligible employees, other than our Chief Executive Officer (i.e., so that the new stock options will cover half as many shares as the corresponding surrendered options) and (b) 3.5-for-one basis for new stock options for our Chief Executive Officer (i.e., so that the new stock options will cover a number of shares equal to the quotient of the number of shares covered by the corresponding surrendered options divided by 3.5) …. Our Board of Directors believes that the proposed Option Exchange would create better incentives for employees to remain with the Company and contribute to the attainment of our business and financial objectives.

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  9. Weight Watchers should ask itself why it wants to retain those executives who oversaw such a large drop in value...

    If the prior options didn't motivate them to do such a good job, why will these new options motivate them?

    I wish shareholders would ask these types of questions rather than just blindly passing all of management's resolutions.

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  10. Red, now that your out of E, what are your thoughts on HOS? Seems like a nice company, oligopoly, protected by assets (50% discount), v solid management and potentially trading on a v cheap FCF multiple. And exposed to GOM with lower break even costs to drill as Canada.

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  11. I don't get HOS: i don't see why it shouldn't always trade at discount to assets; I don't see the future v low FCF multiple; and I don't see why it's a better r/r than other OSV companies trading at lower multiples, with better clients, no spot exposure, and at least acceptable ROICs.

    Not for me.

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  12. You don't see utilization rates recovering? Or you think dayrates will become more depressed? It seems currently they will muddle along with a 10x multiple. But if utilization would recover to 80%+ FCF would be a lot higher?

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  13. I'm looking at trailing #s which are a good proxy for a reasonably optimistic view of the future:

    EBITDA 284
    MCX = D = (71)
    Tax @ 37% = (63)
    Unlevered Operating Profit = 151
    10x = 1510
    Net debt = (810)
    Value of Equity = 697 = $19/share

    Bottom line is that this is a biz that is unlikely to earn > 10% ROIC so "owner earnings" is more relevant than FCF.

    Looked at another way:

    IC = 2588
    ROIC = 6.5%
    Value at 10% WACC = 1670
    net debt = (810)
    Equity = 860 = $23.50/share

    Could the stock rocket higher in a relief rally? Sure. But is it actually worth more than $25? I don't think so.

    To frame why not:

    When it was at its 52-week high the EBITDA multiple was the same, to pick a name out of the hat, as Boeing's - 8.9x

    Boeing earns 27% return on capital, not 6.5%.

    Boeing is in a privileged position at the early stages of a supercycle.

    Boeing's EBITDA has grown at 11% per year for a while.

    Boeing pays out 45% of its earnings as dividends.

    Boeing and HOS shouldn't ever trade at similar multiples, imo.

    Something like HOS should trade at 4.5x to 5x "normalized" EBITDA

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  14. Your ebitda asssumption 285m$ seems a bit on the low side? Currently they are on schedule to do 245m$ and they still need to take delivery of 8 ships that will be higher margin and more revenue on average then the current mix (due to older 200 ships that are somewhat in oversupply now, and the ones that are stacked).

    So if you believe that utilization can increase on rising oil at some point to 80-90% range (with their now more competitive mix of ships) then ebitda could go between 450-600m$ range in a recovery? Would also need higher rates to get to 600m range.

    And depreciation will be a lot lower then cap ex for some time to come.

    So then I get around 200-300m$ in FCF.

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  15. Btw to add, a good way to think about it is DWT. Currently DWT is about 210k (i dont think they break out MPSV?)

    And 150k will still be delivered that is mostly paid for.

    So if we assume a higher utilization + 360k+ in DWT, you get between 7-9$ per DWT in revenue if 100% utilized. That would be between 920m$-1.18bn$ in revenue (way beyond current annualized revenue of about 550m$).

    They averaged 87% utilization, and utilization will be improved in the next years with their new ships vs the past few years.

    So that means revenue will be much higher, and 285m$ in ebitda would be lowballing it, and 25$ would be kind of your downside case?

    This would also mean improved ROIC (if oil, and the situation in GoM does not stay depressed ofcourse) and so a higher ebitda multiple?

    Anyway thanks for taking the time to respond.

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  16. Dont want to muck up your comment section, but made a mistake, it is 292k DWT, i included the ships they sold (and will sell) I think.

    So an average case with 9$ in revenue per DWT and 85% utilization that is about 850m$ in revenue. with 47% (this could be higher, with new mix of ships?) ebitda margins that is about 400m$ in ebitda. But they incurred training costs that are one time of between 20-40m$? (hard to estimate, but going by Q4 conference call).

    So that is 420-440m$ in ebitda in a base case?

    That would be about 130% upside with a 6x multiple? And assuming depreciation is not much lower then capex for some time to come, almost 200m$ in FCF at the very least.

    Your better at this then I am , so I could have easily made a mistake

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  17. I get it. I've read the investor presentations and what I see is tremendous operating leverage. Day rates > 20K and you make a lot of money. Day rates < 18K and you lose a lot of money.

    So an investment thesis has to consist of: day rates will not / can not go below 18K because...

    And just how one constructs that argument is above my pay grade. Again, I have read the investor presentation and have seen their attempt to anchor it in adjusted historical day rate figures.

    This could be like GLBS at $3.30 so it's worth considering whether day rate risk is something you want to take on and whether this is the easiest way to earn a possible 100% upside in the O&G space.


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  18. Any reason for the BioSyent exit? I own it and like the co very much.

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  19. Hi Prasanna,

    Not a top ten idea for me right now. I had thought there might be a gap fill between the generics scare and the earnings release date but that didn't really happen.

    Beyond that and for the LT it's a matter of quantifying the tradeoff between generics risk and intl growth. It looks favorable enough. I'll be tempted if the stock comes down to $5.50 and below.

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  20. Hey Red,

    Did something change for you re OPRX? How are you thinking about the whole copay-coupon legal/regulatory risk? If branded copays are no longer supported, do you expect specialty/on-patent copays and vouchers to provide an adequate market to support the stock price?

    Thanks in advance.

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  21. Hi Red,
    what is your take on MCR quarterly results?

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  22. Re: OPRX

    I see the potential veterinary market as a third leg and think that it more than makes up for the regulatory risk you're describing.

    There are a number of what are for me non-core ideas that I'd like to jump back into in the latter half of this year after I make sure that this year is taken care of. The market for my core holdings has been choppy so just when I think I'm set it turns out that I'm not :)

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  23. Re: MCR

    Q1 and outlook made sense to me and I'm encouraged by the bonding/preparations for large projects. MCR seems to me a free option on potentially explosive growth if some FIDs are arrived at wrt to LNG, starting with Petronas.

    I note that it trades at serious discount to trailing or forward EBITDA multiples of its worse placed peers, that it is not bleeding cash, and that the MSA/maintenance work is keeping it profitable as we theorized that it would.

    As cash builds it seems to me that the MOS will rise at an acceptable rate.

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  24. red,
    Cerf Inc could be interesting. Fits into your circle of competence (canadian small cap, equipment rental). http://seekingalpha.com/article/3216176-dividend-and-growth-investors-buy-cerf-incorporated-hand-over-fist
    Did you look at them in the past?

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  25. Thanks Martin. I looked at CERF, E and MCR at about the same time. Do you like this stock?

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  26. I read your write-ups of E and MCR and bought just MCR, when the price fell [long MCR]. I don't like CERF, but at the right price I would buy nearly everything. Stocks I like are the ones I have hold for over 10yrs like Nestle, Altria(compounder, moat)[long both] and can't sell due to tax reasons.

    The communication of CERF is a bit too promotional for me. http://web.tmxmoney.com/article.php?newsid=75800149&qm_symbol=CFL
    They should focus on per share value.Shares up from 16 to 32 mio YoY. Maybe management is building an empire?

    in the MD&A (page 8) Maintenance capital was kept steady YOY, which is not plausible. http://cerfcorp.com/pdf/news/2015/15-05-29%202015%20Q1%20MDA.pdf

    Even with some adjustments (higher mcx, share based comp) cashflow yield for the year should be above 10% and the waste management seems defensive. If I would just knew management were honest and focused on per share intrinsic value I would buy. Balance sheet provides no downside protection at this price (goodwill, intangibles). Would like a lower entry as always. I have lost ~5% over the last year due to frauds and I am very sensitive to even small things which look implausible to me and promotional spinning.

    E.g. if I would know future bright to be not fraudulent in any way, I would buy, too.

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  27. Hey red you have any idea's on a possible long term buy and hold portfolio? More like long term compounders instead of exploiting short term inefficiencies. Like buying 5-10 stocks and not having to look at them and still expect a 10-20% return? Ofcourse accepting a lower IRR, but almost no work, except for the initial work ofcourse. Just as a thought experiment.

    Something like:
    Boeing
    Google
    Liberty media
    Schibsted
    James Halstead
    Mastercard

    And just plowing 10-15% in each with some cash left over. With about 20% in Schibsted. Thoughts?

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  28. Martin,

    I like your analysis of CERF. Thanks for sharing it.

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  29. red,
    the SA article was not written by me but I like to read articles of the author. Thanks for writing in your blog. I read everything.

    BTW why did you sell OPRX? http://www.sec.gov/Archives/edgar/data/1448431/000121390015004231/fs12015a1_optimizerx.htm
    I don't like "The Shares Issued in Connection with the Merriman Capital, Inc. Advisory Agreement".[was never long OPRX]

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  30. .. to be continued in next post. I'll also talk about upside and timing, tie the three (safety, upside, timing) together, and relate them back to the road map idea. In the post after that, I'll give my current holdings the same treatment as I did the names that have played out and see how they stack up. I'll then say something about how and where I look for ideas. 

    red, will u be making this post soon?

    btw, do you own any bonds now? im curious what u think about bond etfs like mub, bnd, etc ?

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  31. How much do you get in PBT for Flybe? This is my calc:

    69m in 2014. But add back 26m for E195, 12m for Finair write off and 4m for E261.You get 111m. But some of those cost cuts of 2014 are not fully reflected in those (cannot find out how much though). Then I get about say, 120m in ebitdar? Add back 80m in rental (since we already added back those one time E195 rental costs), 14m of D&A and a tiny shred of interest and I get 25m of PBT.

    But I wonder how much route maturation, white label and all those little things will add. Seems about 150% upside if you add in the cash with that number though? It seems it could easily go to 40m two years from now though. With efficiencies and new measures kicking in.

    Thanks for giving me the idea.

    Agree with this sentiment? Im long as well.

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  32. TTM UK airline EBITDA = 118
    Incremental cost cuts = 24
    Adjusted EBITDAR = 142
    5x = 712
    (Net debt equivalents) = (350)
    Max cash cost of E195s = (80)
    Equity = 282MM, or 126p/share

    or
    TTM PBT from UK airline = 36
    Incremental cost cuts = 24
    Adj PBT from UK airline = 60
    Capitalized at 6x = 360
    Max cash cost of E195s = (80)
    Residual = 280MM or 126/share

    plus
    Disposal of MRO business
    possible disposals of E195s at less than max cost
    Earning power of net 3 Q400s from RJET
    Possible contract flying runway

    Ultimately I think this stock goes to 250p to 300p over the next two or three years. The important thing is that the mgmt team apply their collective experience from easyJet's turnaround and not snatch defeat from the jaws of victory by expanding into (and staying in) unprofitable routes.

    The market seems to have capitalized the E195 losses (unreasonable) and is aghast at the strategy of taking on the LCCs and BA from the City airport (reasonable).

    There's a core business in there that's profitable and competitively advantaged and I'm counting on Saad'steam to be as data driven as they have been in the past.

    Thanks for reading

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  33. Sorry & yes. I ration time spent on investing and have lately needed to find new names and to answer time sensitive blog-related email.

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  34. What happens to the warrants of Enterprise (if you still hold them?) when shares are split 4:1? Does the strike price stay at 1$? If this is not a automatic rule, then I can see why they want to split the stock.

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  35. The strike price becomes $4

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  36. Red,

    Emeco is falling again and I can´t find any news in the web. Do you have any news of what is happening?

    Thanks.

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  37. I suspect it fell because the Australian market as a whole was also down

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  38. Hey Red,

    What are your thoughts on Lanesborough at these stock and oil prices?

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  39. Red,

    An article of Virgen America. Maybe you find it interesting.

    http://www.fool.com/investing/general/2015/06/18/virgin-america-stock-suddenly-looks-more-enticing.aspx?source=iaasitlnk0000003

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  40. Thanks David. Virgin America is an overpriced stock in a bad market.

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  41. Is there going to be a catalyst for those options? I saw you did not cash them out when they were trading at 5$ a while back.

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  42. Hey Red,

    Do you mind sharing why Findel does not have a spot in your main portfolio? Is it a matter of liquidity, timing, or risk tolerance? There seem to be a lot of factors indicating potential M&A in the near future, and I see it is a top position in your UK based portfolios both here and on stockopedia.

    Of course given the recent rout in HK equities I can see there being a great deal of competition for your already limited capital.

    Thanks in advance

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  43. Thx for the question

    Long answer and maybe more than you wanted to know. It's a combination of factors.

    A) I own too many names-- as a matter of principle. If I were to start from scratch I'd own Texhong (20%), Keck (25%), Future Bright (20%), Flybe (10%), & Rain (10%) and that's it. That's in my mind probably enough to get an annualized 40% over the next 18 months and would leave cash on hand just in case a trade of a lifetime pops up (esp in light of the shenanigans in HK) Not suitable for everyone, obviously, but that's the kind of structure that would suit me fine

    Path dependence. Now that I'm in the position that I'm in

    B) Half my portfolio is engaged in the Macau trade. Short interest is high, the IVS restrictions have been lifted, YoY GGR declines should have ceased and MoM GGR growth of 10%-15% should be kicking in. So I'd like to keep that trade on until sentiment has reversed.

    B) the Texhong investment is at its half-life but I think it reports numbers in August that justify a near term $9 to $11 valuation before kicking on toward $18-$20 next year. I'd like to lighten up at $11. Ditto Rain Industries which looks to have turned the corner and is heading toward 9% EBITDA margins and Rs 100-120/share valuation (esp now that the Pabrai cloners may jump into this stock).

    C) Flybe and Macro's fortunes could turn in a day, on a single news item.

    D) I'd take back Dolphin & Lanesborough knowing now that the HK market has turned wobbly. But now is probably not the best time to sell them.

    E) That leaves bits and bobs that are, I think, similarly situated to Findel: HSP, NSP, KTCC, Artnet & RJET. They look like (and probably will turn out to be) hard work when compared to Findel and that's frankly probably a reflection of the mood I was in when I bought them -- playing the long game and being vain rather than plucking the low hanging fruit. If it weren't my own account I think I'd own something like Findel rather than somethiing like RJET or HSP.

    Of course, there are other stocks that are relatively uncomplicated and, I think, good value. Some names of the top (and my estimate of fair value): Information Services Group ($8.50), Northbridge (550p), Tourism Holdings ($3), Linedata (E50), CDW Holdings ($0.36), Lifeline Scientific (220p), FormPipe (DK16), Kalibrate (200p), Nirvana Asia ($3.50), XiabuXiabu ($6.50), STW Communications ($1.10), etc

    So long story short: it's not Findel (or Hogg Robinson, for that matter), it's me.

    Clear as mud, eh?

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  44. What do you think about the cyclicality of MB holdings? They really crashed in 2009. It seems the market is scared for another crash in profits judging by the large drop in share price? I saw on your twitter that you thought they could do 130m$, but it seems they can also easily do close to zero? And you are not much protected by their assets. They largely depend on discretionary spending it seems. The type of names I would not be that happy to own. But maybe you are seeing something here that I don't.

    Anyway thanks for the treasure trove of idea's.

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  45. if you're lookingfor a LT and rapid compounder with barriers to entry this isn't it :)

    but I'll say my piece about it anyway just in caseanyone else wants to look:

    I think what happened in calendar '09 was that a number of levered salons when bust and took their customers' prepayments to the grave. That affected trust and collapsed gross receipts and therefore revenues. Plus MB had too many stores servicing a suboptimal number of cutoners each so op leverage was particularly pronounced. .

    And then, in calendar 2012, this happened
    http://webcache.googleusercontent.com/search?q=cache:b6nbOK_vqgAJ:www.scmp.com/news/hong-kong/article/1120095/beauty-industry-crisis-hong-kong&hl=en&gl=us&strip=1&vwsrc=0

    and that caused an even bigger kerfuffle from which MB is just now emerging. So things like that could happen again and that's the risk.

    OTOH I think HK normalized, across a full cycle, earns 95 in Services EBIT and 28 in product EBIT. I think Sing/Malaysia earns 23 in service EBIT and 3 in product EBIT after partly adjusting for weak SGD/HKD.

    Important notes: (A) it appears that the 376K customers are ~100% HK residents rather than including PRC residents. So MB seems to have somewhat incredible market share (addressable pop = max 1.5MM).; (B) in HK service retail everything eventually comes down to rental rates so one has to be comfy about MB's pricing power.

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  46. makes sense, thanks.

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  47. Red, thx for your continued sharing of your thought process & ideas. i think it's some of the best work out there, when are you going to run a fund!? Looking through your list of quick ideas above, take LSIC for example

    What jumped out at you about this / how didyou find it? Quick look at the numbers and I see a steadily growing business with a consumable element, but volatile returns and no FCF. ROICs are currently 10% or below. Even if i somwhat blindly assume that margins go back to the mid-teens, it's still trading at a 10% yield with FV around $2.20 using 10% WACC but still unclear on cash flow. I'm a big believer in normalizing margins/returns, but this is an example where just taking a simple average of margins/returns doesn't show it to be undervalued. curious to your brief thoughts? or if another example clarifies it, just picked LSIC as an example.

    Also, would definitely be interested in more posts about your process...

    - how many annual reports do you read per company (2 years, 10 years?). How long before you go from reading annual reports to excel modeling?
    - do you find most ideas by reading competitors annual reports? how long do you spend on each competitor's report?
    - do you keep a word doc with detailed notes on each company? what kind of things do you note / how lengthy do these become? how are they organized?

    have a million more, but would appreciate any insight as usual!!

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  48. Thank you for the thorough responses to the many questions.

    Having only experience investing in "Western" companies, what are the things you are looking for when investing in China or Honk Kong listed companies?
    What are the pitfalls try you avoid?

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  49. Barry --

    I stumbled on LSIC (I think I was looking at comps for Clinigen and noticed it that way).

    Brief look --->
    -- medical consumables,
    -- niche, patented, big market share, outsized R&D spend
    --hasn't expanded int emergin markets yet
    -- 65% gross margins,
    -- SG&A = large as % of revenue so operating leverage with growth?
    -- 3x the market cap in net operating loss carryforwards

    ROIC = 15% and under-levered so could do 30% ROE without a fuss

    BUT, US-domiciled biz listed in the UK. Why?

    The above would be a first cut and enough to prompt me to follow up by reading its annual reports and whatnot and I'd go back far enough to get comfortable that I've understood the story, the drivers, the risks etc.

    Normalizing is fine in some circumstances and, I think, inappropriate in others. If a biz will grow and has operating leverage the 10 years ahead will likely look much better than the decade prior.

    If, on the other hand, a business model is close to its expiry date then normalization is,more likely than not, going to kill you.

    Anyway, I'd thought it was still trading inthe 170s when I mentioned it above and the premise was that it was low risk as is (it's a perfect tuck in acquisition for larger medical device companies and they'd pay 10x EBITDA for it) and that, if/when emerging mkt growth and operating + financial leverage kick in. it would be worth more.

    Go out 3 years and say that it generates sales of 50MM at 63% gross margin. R&D is 3 and SG&A is 20. So EBIT is 7 and can support 1.5MM in interest payments and therefore 17MM in 6% debt. It won't pay taxes so owner earnings = 5.5MM and growing. Most people would be happy enough with an 8% yiield on a biz like this so 5.5/8% = >$68MM mkt cap. And medical device companies trade at earnings multiples of 15x+ so maybe multiples expand as it gets bigger and it goes to > $80MM market cap.

    So, an interesting opportunity at, say, sub-30MM mkt cap. If it were at 25MM I'd do a lot more research on it -- try to find industry journals/webside, look up trends in renal disease, look into the whys and wherefore of the UK listing. and generally tie up the details.

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  50. Anon @ 3.42 AM

    Hmm. Broad topic but, at bottom, one is looking for a plausible business with long and uninterrupted history of uncomplicated and exemplary behavior selling at a valuation that you can't find in your home market.

    A plausible business means that that it earns the margins it should, turns its assets over as it should, and that pays out an appropriate share of its after-tax income to holders of the common equity. Just the sort of things one would look for in the AIM market for family-controlled companies but with heightened attention, esp to the cash flow statements and to comparable companies.

    if it sells X amount, for example, one can back out the implied market share and assess its likelihood. If gross margins are y% one can look at closest comparable companies and assess its reasonableness. One can look at the owner-manager's compensation package -- pay, rights offerings, minority interest stakes by related-party entities, etc -- and assess whether it is reasonable in relation to value created for the common.

    A fast growing company (>20% CAGR) should nevertheless pay out 20% to 30% of earnings in dividends and, the slower its growth, the higher the payout ratio should be until it reaches 100% at 3%-5% growth.

    Letting cash pile up forno specific reason is no good. A consumer goods business suddenly branchng out into real estate development/speculation is no good, A PRC company listing in Singapore is no good. Etc

    Generally speaking, names that local value investors (e.g. Value Partners) are involved in are interesting to look at. But it's not enough, in my experienc, to assume that they know what they're doing. The whole picture has to hang together & make sense to you, and should leave you with the impression that you have a reasonable basis for predicting what the business's fundamentals and the owner's behavior toward shareholders will look like over the next 3,5, and 10 years.

    One good place to start looking for a potential first investment in Asia would be the major conglomerates -- Hutchison Whampoa, Hopewell, Cheung Kong, Wharf, Wheelock, Swire, MTR, Jardine Matheson, Minor International, HPH Trust, etc etc. These are collections of high quality assets that are valued (by the market) in relation to book value. Not unusual to see them trading at 60% of book when they have compounded book (and likely will compound it in the futiure) at 10% to 15% rates. Also, they're involved in all kinds of activities and being involved with them gives one insights into how the Pacific economies work at the microeconomic and sectoral levels.

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  51. Thoughts on Macmahon? it seems 40% of their market cap is net cash now. And a 2x multiple on FCF? It looks really cheap still after the mongolian sale?

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  52. Red, what do you think about Bracell? It seems to trade a 5.5x earnings yield (backing out those one time charges). They are a competitor of RYAM but dont seem to be so heavily in cigarettes. And they have much lower costs. It could become interesting as profits could be squeezed in the short term by too much supply. But it seems a very interesting industry with high barriers to entry.

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  53. Hey Red,

    Thanks again for portfolio construction info re Findel, and congratulations on your (and my by proxy) success in Flybe.

    Taking a quick peek at Haichang, I think I must be missing something as I can't seem to get to a valuation in excess of HKD 3 out a few years. I assume the discrepancy lies in converting land to income generating properties (50% NAV value to 10x EBITDA based on peers and typical RE HK valuations), and upside in the management business? Or do you perceive the risk profile of this investment to be low enough to be satisfied with a lower IRR?

    I am also curious if you have any thoughts on RR.L? Greenwood has some research out on it, and seems to think they can hit teens EBIT margins and a price target in the 20-30's (2018) through a combination of vertical integration/supply chain rationalization and aggressive buybacks.

    A final idea I am interested in is ZINC - it appears as though the current valuation implies the new plant will operate at 50% capacity perpetually. Mr. Pabrai has recently added to his position(implying he sees a 4x in it based on his portfolio rules), and comparable projects have ramped to expected capacity over reasonable time periods. It doesn't seem unreasonable to see utilization ramping through late 2016 and a valuation in the 20's before making any assumptions about Zinc prices. I expect you are aware of the situation, but just in case it slipped by I thought I should mention it.

    TIA

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  54. Hi Ruby

    re: Haichang
    Property Division at 50% of assets = HK$ 1850
    Shangha NPVi at 1.1x cost to build = $3,500
    (Net debt) = (1,700)
    Subtotal = $3,650

    Market Cap less 3,650 = $2,400 = 5x trailing EBITDA of the parks business. That's too low. Every other such business, from SEAS to Straco trades at 9.5x+.

    So, first step: add (10-5)*475 = $0.60/share to the valuation ==> $2.10 or so That's simple MOS for the moment.

    Next, I think Parks EBITDA triples by 2018/9, The newer parks are operating well below capacity; in-park spending is too low; the tour/individual ticket mix is poor; the ticket prices are too low in absolute terms; and capacity itself is too low since there's room to open in the off-seasons and in the evenings. (Check the fall off in gross profits pre and post 2010 to get a sense of this). Plus the cities in which its parks are located have experiences sustained mid-teens growth in domestic tourism

    Virtually every dollar of incremental ticketing revenue is accretive to EBIT. This is a fixed cost business. So add $1.85 in value/share and that gets us to $3.95. That's ~30% annualized and seems highly probable to me.

    Now, the property division is obviously not sitting on its assets. It's selling them at market value. So to be realistic, I would value the real estate properties at 90% rather than the traditional 50%.(And the book value of the properites will grow with time and as they are developed, but we'll set that aside) That would add another $0.35/share. So, to me that looks like close to a 2.5x return from here over the next 3 years without great risk of something terrible happening in the interim.

    I think Haichang is large enough, uncomplicated enough, and visible enough that institutional funds will bid up the shares to $3 and beyond as soon as the operating leverage becomes visible (and as soon as the HK market stabilises). And if that is so then then based on the latest release on traffic that should happen when the next annual results are released (which is why I own it now rather than later even though I need the cash for other ideas).

    RR - I hadn't at all noticed the recent price action. Now I understand why it's all over my twitter feed. I'll revisit it. Thx for the prompt/pointer.

    If you like ZINC it's worth comapring the convertibles to the stock.

    Glad we've made some money on Flybe. I think there's a little bit more to come yet.

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  55. The march 2016 options might be worth a look as well, given the speculative nature of the stock.

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  56. Hey Red,

    I'm curious to know the rationale for adding to Flybe here? Is this more of a short term trading opportunity? Also if you have any opinion on the price action at RJET I would love to hear it. Seems the market thinks the business is broken on the back of lengthened labour negotiations.

    Thanks for taking the time to answer so many questions on this blog. Onwards to Texhong 1H results!

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  57. Flybe: there's more information in the latest trading update that gives me greater confidence that things will work out according to my expectations.
    RJET: there's a number that works for both the pilots and for the equity. Management needs to come to terms with thatand act accordingly. Whether it will come to terms with it or not is anyone's guess. In the meantime, the equity is now trading at cash. We'll see -- it's a (for me) small position and what mark-to-market damage there is to be done has now mostly be done. I'll turn my attention to it after my vacation.

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  58. Regarding your Dawson bet, arent you afraid fracking is in somewhat of a bubble? A lot of these companies werent making their cost of capital at 90$ oil, let alone now. half the oil is from fracking in the US. If that is reduced, isn't that going to be bad for Dawson? Especially since that industry isn't exactly a dream business to be in.

    It seems like betting on oil recoveries in canada or deepwater oil is a better way of playing the oil recovery?

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  59. You like Horbeck better. I heard you then and I hear you now.

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  60. Dont own Hornbeck, and got a small position in Dawson.
    I started looking at the income statements of a lot of large oil frackers recently after reading the einhorn report, and even at 90$ oil they look ugly. So if going forward only 6-7m barrels are produced in the US (a sizable part offshore), how does that affect Dawson? Wasn't a large part of their earnings in the past decade due to the fracking boom? And isn't the seismic industry more cyclical then oil?

    Isn't this largely an indirect bet on oil fracking in the US?

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  61. Any particular reason for the Republic exit? More FB cash? I'm still holding and praying for a quick resolution.

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