Monday, August 21, 2006

Long case for Realogy (H)

Realogy which was recently spun-off from Cendant is the largest listed provider real estate and relocation services in the United States and internationally. It operates in four segments: Real Estate Franchise Services, Company Owned Real Estate Brokerage Services, Relocation Services, and Title and Settlement Services.

A few days ago I acquired a long position in Realogy @ $ 20.60 and feel there is a simple and compelling long case as:

  1. Realogy is the largest business of its kind and the only listed one. I believe it is about 3 times larger than its closest competitor Homeservices of America which happens to be owned by Warren Buffet who has called it "a gem".
  2. Management has a large material interest in the firm. Henry Silverman who was the CEO of Cendant prior to the spin-off chose to go with Realogy. I believe this speaks volumes for who people who are "in the know" chose to align themselves with.
  3. Management has stated that they might buy back shares and also that once an appropriate amount of time has passed since the spin-off they will "consider all offers" to buy the firm.
  4. The current slowdown in the real estate market provides an excellent opportunity for Realogy to consolidate and build on its leading position in the market.
  5. Post spin-off dynamics combined with all the negative publicity about the state of real estate industry have put pressure on Realogy's shareprice and provided a buying opportunity at depressed prices.

It seems to me that as there are no other similar listed firms the market is not entirely sure how to price Realogy. However one has to keep in mind that unlike homebuilders Realogy is a services business that carries no inventory, is not at all capital intensive and makes money on either the buy or sell side.

Keeping the above in mind, the fact that the real estate market will rebound at some stage and the possibility that Realogy could be taken over I am happy to hold on, and even add to my position in the long term.

Thursday, August 10, 2006

Sara Lee spinoff of Hanesbrands

A few days ago Sara Lee finalized the spinoff of Hanesbrands to its shareholders.

A few gleanings from the updated Form 10:

1. HBI will have only around 95 million shares outstanding: - This could cause liquidity issues and exacerbate any short-term pressures on the stock It seems likely that institutions and fund managers might dump a lot of HBI shares given that HBIs debt has been rated ‘junk’ and there is no certainty yet around which index’s HBI will be included in.

2. HBI management will be exceptionally well rewarded: - The Hanesbrands Omnibus Incentive Plan of 2006 allows for a total of 13.1 million shares or about 13% of outstanding stock to be issued to directors and employees. Initial awards will be issued on the 15th trading day following the distribution date and the excersise price will be 100% of the fair market value of the stock on that date.

It seems to me that it would be to HBIs management’s advantage for its shares to trade down till their stock options are priced on the 15th trading day following the distribution date.

I intend to hold on to my SLE shares. Also given how well incentivised HBIs management is going to be to ensure that it outperforms I may well increase my position in HBI should an opportunity to buy at depressed prices present itself.

Thursday, July 13, 2006

GenCorp (GY): Paying fifty cents on the dollar

GenCorp’s primary business is in the aerospace and defence industry. It designs and manufactures missiles, rockets, propulsion systems, etc. Business has not been very profitable lately. GenCorp reported a loss of $ 23.3 million on sales of $ 167.4 million in 1H 2006, a FY 2005 loss of $ 230 million on sales of $ 624 million and a FY 2004 loss of $ 398 million on sales of $ 499 million.

I guess by now you’re wondering why I like GenCorp and why I’ve just gone long GenCorp at $ 15.25?

Well the answer is hidden in GenCorp’s Balance Sheet and notes to accounts. In the 1950’s as part of its aerospace and defence industry business GenCorp acquired around 12,600 acres of real estate near Sacramento, CA. This real estate is carried on GenCorp’s Balance Sheet for less than $ 30 million.

The 12,600 acres or approximately 21 square miles of raw land is adjacent to U.S. Highway 50 between Rancho Cordova and Folsom, California east of Sacramento. An acre of entitled land in this area is worth about $ 200,000 or $ 40 per share of GenCorp.

Given the fact that GenCorp has 51.51 million shares outstanding, the total value of land owned by GenCorp, if the land were to be split into finished lots and entitled is just over $ 2 billion at todays prices. Contrast that with the fact that GenCorp's market cap is only $ 850 million and EV is $ 1.26 billion.

So you're now thinking that may be this looks good but its probably not worth the investment unless GenCorp actually develops, entitles and sells off all that land. Well that is exactly what prominent activists shareholders are pushing GenCorp to do.

Major shareholders include Pirate Capital, Carl Icahn, Steel Partners, Sandell Asset Management et al. Almost, if not, all of these and other shareholders are pushing management to realize the value of the real estate owned by the firm. Steel Partners in the past has made an offer to take over the entire firm for $ 17 per share and recently after a proxy battle Pirate Capital managed to get three of its own elected to the board of directors.

Sandell Asset Management in one of its SCHEDULE 13D filings had this to say:

"We have a strong conviction in the view that the intrinsic value of the Company resides predominantly with its extensive and highly valuable 12,700-acre real estate holdings around the rapidly growing Sacramento, CA region .... Unlock the value of the Sacramento Property by separating out the assets in a tax efficient manner such as a spin-off, tracking stock, or via a real estate partnership"

Pirate Capital in another filing said:

"We see 2006 as a critical year for the Company to develop a thorough strategic plan for its vast real estate holdings ... the Company owns vast tracks of real estate in Sacramento, California, and real estate values in Sacramento increased 15% in 2003, 25% in 2004 and 19% in 2005"

By winning the proxy battle and getting its own nominees elected to the board Pirate Capital has made it clear to management that they must perform, realize the value embedded in GenCorps vast real estate holdings and start generating free cash flow or else they will be replaced.

In light of the above and also the fact that I have bought in to GenCorp at a much lower price than the activist shareholders mentioned above I am happy to sit back and go along for the ride knowing that these large shareholders are working to release the value locked up in GenCorps real estate holdings.

Monday, July 10, 2006

Bought Sara Lee (SLE) at $ 16.10

A few days ago I initiated a small long position in Sara Lee at $ 16.10. Sara Lee is a leading consumer products company that has brands in leading positions. However margins have been hit recently due to increases in commodity prices which make up a large portion of COGS. Performance has also suffered due to mismanagement and bad acquisitions.

It seems to me that the street is being excessively pessimistic about Sara Lee’s prospects and is putting the entire firm on sale as if the issues facing the firm are going to continue far into the future.

This works in my favour as I would rather buy a business with average earnings prospects for a good (cheap) price than buy a business with excellent earnings prospects for a bad (expensive) price.

At a P/E of 13.24, P/S of 0.86 and P/B of 3.1 Sara Lee is currently selling for well below its own five year averages and also below averages for other firms in the same industry as shown above. EPS for 2005 is very close to the average EPS for the past give years and this suggests that Sara Lee has been able to maintain its earnings power through the business cycle.

I see things differently from the street. I see an undervalued business that generates strong cash flow which has in place a new focussed management team that has over the last year been conducting an extensive restructuring of Sara Lee. Underperforming businesses have been sold, cash flow has been utilized effectively to buy back shares and pay dividends and the branded apparel business is to be spun off to shareholders shortly as Hanesbrands. Margins should also improve with time as either commodity prices will come down or the foods industry will raise prices.

In “You Can Be A Stock Market Genius” Joel Greenblat writes “… companies that pursue a major restructuring are often among the most shareholder oriented… most managements that go ahead with such a plan have their eye on shareholder interests”. I believe that the completion of the restructuring program and the spin-off of Hanesbrands are the short term catalysts which will unlock the value in Sara Lee.

Estimating Sara Lee’s normalized EPS (ex Hanesbrands) at $ 1.50 and conservatively applying a multiple of 11 one arrives at a price of $ 16.5 for Sara Lee. Therefore it seems that the market is attributing no value at all to Hanesbrands which in its own right generates significant amounts of cash flow. On being spun off Hanesbrands is to pay a significant amount of cash to Sara Lee. Management plans to use this cash towards it plan to reduce debt by 1.5 to 2 billion and to buy back a total of $ 2 billion in stock over several years which should further increase Sara Lee’s value.

Information in the amended Form 10 filed recently reveals that Hanesbrands generated over $ 500 million in cash flow from operations in the 39 weeks to April 2006. While Hanesbrands will take on a significant amount of debt to fund the cash payout to Sara Lee it seems that Hanesbrands will easily be able to service interest payments out of cash flow from operations and this debt will greatly enhance returns.

Assuming a 1:1 spin off ratio there will be 760 million Hanesbrands shares outstanding resulting in estimated cash flow per share of $ 0.65. Applying a multiple of 7 to this one arrives at a value of atleast $ 4.55 per share.

Adding up the sum of the parts i.e. Sara Lee and Hanesbrands I arrive at, what I feel is a conservative valuation of Sara Lee of $ 21.05. This represents an upside of 30% to my entry price of $ 16.10 with not much more downside risk left if the restructuring program and spin-off stay on track.

Also noteworthy is the fact that Pzena Investment Management and the John Hancock Classic Value fund, both run by expert special situations and value investor Rich Pzena has been buying loads of shares and now own about 4.5% of Sara Lee.

Friday, July 07, 2006

Graham & Doddsville Revisted: Why Ive Created This Blog

After being an investor, in the Graham and Dodd tradition, for the past few years, I have decided to start postulating my rational for each investment I make, publicly on this blog.

I hope that by opening up my investment decisions to public scrutiny and criticisms I will gain insight into the thought processes of other like minded investors, share and gain knowledge and improve my investing skills.

I run a real portfolio with real $$$. This portfolio is split in two based on the type of investment which I classify as:

  • Undervalued situations - This is where I buy into a business at a reasonable discount (margin of safety) to my calculation of its intrinsic value i.e. pay 50 cents on the dollar and then wait, sometimes for a few years, till Mr Market offers to buy it back from me at fair value
  • Special Situations - These are investments which rely on a specific corporate action, within six months to a year, for their profit rather than a ordinary rise in the price of the share as in the case of undervalued situations.

Quite often an investment falls into both of the above categories, or moves from one category to the other e.g. an undervalued situation turning into a special situation.

I also run a virtual fund at Marketocracy following the same general structure as my real money portfolio detailed above. Performance and other details about the virtual fund, which over the past 12 months has outperformed the market by 20%, can be viewed here.

My aim with both my real portfolio and the virtual fund is to outperform the market over the long-term. Unless I achieve this goal it would not be worthwhile to put in the time and effort required to manage my portfolio. In the long run I would consider a year where my portfolios return was down 5% versus the market being down 10% far more superior to a year where both my portfolio and the market were up 10%.

I shall post details of investments I have made recently soon.