A Tale of Two Gas Stations: Long Susser Holdings, Short CST Brands

The following is a guest post from Tsachy Mishal of TAM Capital Management, who presents a look at a gas station pair trade, if you will.  Tsachy also runs the blog Capital Observer.

Market Folly readers will recall that hedge fund Scout Capital recently disclosed a position in CST Brands and this write-up presents a different viewpoint.


A Tale of Two Gas Stations: Susser Holdings & CST Brands


Susser Holdings (SUSS) and CST Brands (CST) both operate gas stations with convenience stores attached. Susser Holdings came public in 2006 with private equity backing, while CST Brands is a recent spin-off from Valero (VLO). On the surface a spin-off would seem far more attractive than a private equity backed IPO, but looks can be deceiving.


Business

Over 80% of Susser’s gas stations are located in Texas, the second fastest growing state in the US. CST’s gas stations are located across the southern US and Canada, with about a third being in Texas. CST mentions Texas numerous times in their Form-10 as a stand out economy and a driver of growth From the CST Form 10:

"The economy in Texas has fared better than many other parts of the U.S., partly supported by a solid economy, a relatively stable housing market and strong population growth and job creation. We have also benefited from the significant increase in economic activity in Texas that has resulted from the increased oil and gas drilling activity in Texas. We have a large number of convenience stores in Texas, and these operations have benefited from the increase in population resulting from employees of the oil and gas industry who have moved to Texas to support that industry."

On the basis of location, Susser has a clear advantage over CST with a much greater percentage of its gas stations being in Texas.

Susser earns the majority of its profits from convenience store sales while CST Brands is more heavily dependent on fuel sales. In 2012 59.7% of Susser’s gross profits came from merchandise sales, while 40% of CST Brands’ gross profits came from merchandise. The reason for this is that Susser’s average convenience store footprint is 3,600 square feet, while CST’s average footprint is 2,200 square feet.

Susser’s larger footprint allows it to sell fresh food and earn more from its convenience stores. CST Brands realizes that it is preferable to have a larger convenience store footprint and is planning larger footprints for its new stores but that doesn’t help its existing store base.

CST’s heavy dependence on fuel sales is a negative for a number of reasons. As Americans have been driving less and driving more fuel efficient cars, fuel usage in the US has been declining. By contrast, convenience store sales have been steadily increasing. Additionally, 2012 was an abnormally profitable year for fuel sales that is unlikely to be repeated.

As oil prices decline, gas stations are slow to lower prices. The $35 oil price decline in the second quarter of 2012 was a bonanza for gas station owners. In 2012 fuel gross margin for CST brands increased by 2 cents a gallon or $40 million, primarily as a result of this extreme downside volatility in fuel prices.

It is very unlikely that we see such an extreme move in oil prices this year. As a result, year over year fuel gross margin should decrease by close to 2 cents a gallon resulting in lower year over year earnings and EBITDA for all gas stations with a disproportionate effect on CST Brands due to its reliance on fuel sales.


Operation Performance

In 2012, Susser had same store merchandise sales growth of 6.6% and per store fuel gallon growth of 5.8%. CST does not provide historical same store sales numbers but does provide “per store” figures. In 2012 “per store” merchandise sales actually showed a slight decrease while per store fuel gallon sales showed a less than 1% increase.

In the first quarter of 2013 CST provided SSS figures for the first time and showed US SSS down 1.6% compared to Susser growing 4.2%. This is likely attributable to CST’s older stores and larger dependence on cigarette sales, which have been in secular decline. Cigarettes make up 40% of merchandise sales for CST compared to 19% for Susser. Dollar stores have recently moved into this category, which will increase pressure. Susser has clearly enjoyed superior operating performance to CST Brands.


Management

The Susser family has been in the gas station business since the 1930’s. Sam L. Susser, the CEO, joined the company in 1988, when Susser operated five stores and had revenues of $8.4 million. Sam Susser grew up in the gas station business, has 25 years of experience and a proven track record.

Kimberly S. Bowlers is the CEO of CST Brands. Below is her bio from the CST Form 10:

"Ms. Bowers was elected Chief Executive Officer and President of CST effective January 1, 2013. Ms. Bowers served as Executive Vice President and General Counsel of Valero from October 2008, and previously served as Senior Vice President and General Counsel of Valero since April 2006. Before that, she was Valero’s Vice President–Legal Services from 2003 to 2006. Ms. Bowers joined Valero’s legal department in 1997. Ms. Bowers was elected to the board of directors of WPX Energy, Inc. on December 30, 2011."

In other words Ms. Bowers, the CEO of CST Brands, has been a lawyer her entire career and has little operating experience. I’m certain she was a very capable lawyer but that does not make her a capable CEO. If experience counts for anything, then Susser has the superior management.


Valuation

Considering that Susser has the superior store locations, a superior business mix, superior performance and superior management one might conclude that Susser should trade at a premium to CST Brands. One would be wrong. Susser Holdings trades for less than 6.3 times EV/LTM EBITDA, adjusting for their ownership in SUSP (slide 21).

CST Trades for roughly 8 times EV/LTM EBITDA. Instead of trading at a premium Susser trades at a greater than 20% discount to CST Brands. This does not take into account that had CST been a public company they would have incurred additional expenses. Additionally, on a forward basis I believe Susser trades at a greater than 30% discount to CST Brands.


Conclusion

CST Brands is a case of “You Can Be A Stock Market Genius” gone awry. In investors haste to buy a “spin- off” they have valued a poorly performing company at an undeserved premium to one if its closest, better performing peers. There are too many geniuses out there right now.


Catalyst

CST Brands has not given any forward guidance so investors have had to create their own earnings models. Many investors seem to have simply extrapolated forward an increase in earnings and EBITDA from 2012 to 2013 for CST. This ignores the one time bonanza in fuel margins in 2012 ($40 million) and the increased costs of being a public company ($20 million). When CST reports second quarter earnings it should become clear that estimates are pie in the sky.


Full disclosure: TAM Capital Management is long Susser Holdings (SUSS) and short CST Brands (CST).

Embedded below is a .pdf copy of TAM Capital's thesis:




We've posted some other investment theses from TAM Capital here.

Crimson Wine Group (CWGL): Bull Case on a Unique Spin-off Opportunity

The following is a guest post by Tsachy Mishal of TAM Capital Management who presents the bull case on Crimson Wine Group (CWGL) which was recently spun-off from Leucadia National (LUK).  Tsachy also runs the blog, Capital Observer.

Crimson Wine Group: A Unique Spin-off Opportunity

Crimson Wine Group (CWGL) is a unique spin-off opportunity. Crimson Wine was separated from Leucadia National Corp (LUK) prior to its acquisition of Jefferies. The stated reason for the spin-off is as follows:

“Jefferies has advised Leucadia that Jefferies’ management deemed Crimson as less strategically relevant than Leucadia’s other subsidiaries, ascribing a value to Crimson no greater than approximately its book carrying value. As such, in assessing and negotiating the terms of the transaction with Leucadia, Jefferies’ management advised Leucadia that Jefferies viewed the pre-transaction divestiture of Crimson through the Leucadia winery business separation an efficient and desirable method of divesting Crimson, as compared with a post-transaction sale or other divestiture. It was therefore agreed between Jefferies and Leucadia that that the separation occur prior to consummation of the transactions, without reducing the book value of Leucadia by more than $197 million and that it be effected without Leucadia retaining any material liability with respect to Crimson.”  

My interpretation of this is that there was a disagreement about the value of Crimson between Jefferies and Leucadia. Jefferies did not believe Crimson was worth more than stated book. That would imply that Leucadia management believed it was worth more than stated book value since they decided to spin this off. If Leucadia management were willing to accept stated book as the valuation than there would be no reason for the spin.

Leucadia management owns a significant portion of the company with Chairman Ian Cummins owning 8.7% of the shares and Joseph Steinberg owning 9.7% of the shares. I believe it is significant that they felt it important to carve out this asset rather than to allow it to be valued at book value. This is especially important because this asset only makes up about 2% of the combined company. If it were worth anywhere close to stated book it would hardly be worth it to spin this off.

It is also worth noting that Leucadia management is in a much better position to value these assets as they have owned some of them for over twenty years. The Jefferies position is understandable in the context of a large financial company. Pro forma for the deal, Crimson would represent approximately 2% of book value. Financial companies are generally valued based on book value. It is unlikely given how small Crimson is relative to Leucadia that the market would ascribe value above book. So even though Leucadia thought it was worth much more than book, Jefferies thought they would never get credit for it in a large financial company.


Valuation

There are two ways to tackle the valuation of Crimson. The first is by book value and the second is through earnings power. I will attempt to do both starting with book value. Below is the pro forma balance sheet given by Crimson. Stated book value is $7.82:

-->

ASSETS
Current assets:
	Cash and cash equivalents		21,329
	Accounts receivable, net		5,287
	Inventory		41,487
	Other current assets		663
	Total current assets		68,766
	Property and equipment, net		108,485
	Goodwill		1,053
	Other intangible assets, net		20,403
	Total		198,707

-->

LIABILITIES
Current liabilities:
	Accounts payable		857
	Accrued expenses		5,393
	Customer deposits		1,178
	Total current liabilities		7428
	Total liabilities		7428
EQUITY
Common shares, par value $1 and $.01 per share			245
Additional paid-in capital			277,176
Retained deficit			-86,142
	Total equity		191,279
	Total		198,707

Breakdown of Wineries 

Crimson Wine Group is in the winery business and owns several vineyards. Crimson lists the value of its property and equipment on its balance sheet as $108,485, which includes the vineyards it has acquired. Crimson has acquired its vineyards over twenty plus years. The land is listed at cost even though the price has appreciated materially. Below is a breakdown of the value of their vineyards:

Pine Ridge Archery Summit - Pine Ridge and Archery Summit are Crimson Wine Groups most valuable wineries.  Pine Ridge Vineyards was acquired in 1991 and has been conducting operations since 1978, Archery Summit was started in 1993. In 2001 they were put on the market by Leucadia for $150 million as seen in this Wine Spectator article. Napa Valley winery prices trade at record prices and at significantly higher prices today than they did in 2001. I believe that this property is worth at least $150 million.

Seghesio Family Vineyards- Seghesio was acquired for $86 million in May 2011.

Chamisal Vineyards- Chamisal acquired for $19.2 million in August 2008.

Double Canyon- Crimson acquired 611 acres in Horse Heaven Hills, Washington for an undisclosed price in 2005 and 2006. A conservative estimate of their land and equipment there is $10,000,000.

The table below summarizes the value of Crimson’s wineries:

-->

Winery	Value
Pine Ridge Archery Summit	$             150,000,000
Seghesio Family Vineyards	$               86,000,000
Chamisal Vineyards	$               19,200,000
Double Canyon	$               10,000,000
Total	$             265,200,000

By assigning a value of $265 million to Crimson’s property & equipment and zero value to its intangible assets the book value becomes $326.3 million or $13.34 cents a share.

By looking at Crimson’s past earnings it is difficult to justify the current price. For the first nine months of 2012 Crimson reported 19 cents of pro forma earnings. However, the future outlook is brighter as earnings are set to ramp up.

Crimson has been significantly increasing production in recent years.  Between 2009 and 2012 it increased production from 117,000 cases to 296,000 cases.  At the same time gross margins have increased from 23% to 52%.  This increase has followed production increases in a relatively straight line as Crimson moves to much higher levels of capacity utilization.  Revenue per case has been between $185 and $235.  After bottoming in 2011 at 185, revenue per case increased again in 2012 as a result of greater contribution from Seghesio which has a higher than average ASP.  During the same period opex has consistently grown slower than sales. 

The Form 10 discloses that in 2013 they will be able to increase production by 58,000 cases at Chamisal and 50,000 at Seghesio.  This leads to total production of 404,000.  Assuming revenue per case of $195 and a slower than historical ramp in gross margins to 55%, this leads to net income of nearly $17 million.  Net income is equal to EBIT because they have no debt and NOLs shield them from cash taxes.  Cash flow will generally be better than net income as maintenance capex is half of D&A.

I estimate that Crimson will earn 70 cents in EPS in 2013 and roughly 79 cents in free cash flow per share. There are two pure play wine companies, Treasury Wine and Concho y Toro. They trade at an average of 20 times 2013 earnings estimates and 14.5 times FCF. Based on these valuations CWGL would be worth $14 on an EPS basis and $12.25 on an FCF basis (once one adds back $22.3 million in net cash). That works out to an average of $13.13, not far from my $13.34 estimate of tangible book value. It is important to remember that CWGL is under earning because its capacity utilization is low.


Conclusion

Crimson Wine Group has all the ingredients of a successful spin-off. The company has savvy management with a large ownership interest, the stock is too small for institutions to hold and there is no sell side following. From the current price of $7.78 the stock has roughly 70% upside to a conservative valuation.


The author is long shares of CWGL. Under no circumstances does this constitute investment advice. Under no circumstances does this information represent a recommendation to buy, sell or hold any security. The information is for educational purposes only. Positions may change at any time without notice.

Why Larry Robbins Likes Life Technologies (LIFE): Stock of the Week

This week's stock is Life Technologies (LIFE).  Larry Robbins' hedge fund Glenview Capital has held LIFE as a core position for a while now, so it's worth examining what they see in the name.  And if you missed them, scroll through all previous stock of the week posts here.

At the end of 2011, LIFE was Glenview's largest disclosed US equity long.  At that time, they were also the second largest institutional owner of the company's shares.

We covered Glenview's thesis on LIFE back in 2011 as it's been a core holding for the hedge fund.  Back then, Robbins argued that the company was cheap on a valuation basis and was likely to grow EPS 20% over the next few years.  He also pointed out that the company's free cashflow was 91% of EPS and its dominant market share versus competitor Illumina (ILMN).


Below we'll hear an opinion from Tsachy Mishal, portfolio manager at TAM Capital Management.

About a year ago I attended an investment conference where Larry Robbins of Glenview Capital made a compelling case for Life Technologies. It was the best investment pitch I heard that day and I left wanting to do more research on the stock. After researching the company on my own, the stock seemed interesting but I was not as excited as Larry Robbins was about it. A year later the stock is sitting more than 10% lower and I have decided to take a fresh look.  

Life Technologies is a life sciences company that sells equipment and consumables to pharma & biotech companies, hospitals, universities, labs etc.  The bulk of their revenue is in consumables which is a high margin, recurring business. The enterprise value (EV) is $10.3 billion and the free cash flow (FCF) in 2011 was $704 million and is expected to grow to well over $800 million by 2013. Life Technologies trades at an EV/FCF ratio of 14.5 times. Considering that revenue is supposed to grow in the low single digits this seems like a fair multiple. 

The bull case is that the multiple does not take into consideration a valuable asset that is currently not generating much revenue and earnings. Life Technologies purchased a company called Ion Torrent for $725 million. They make a genetic sequencer that competes with Illumina's (ILMN) technology. Illumina recently rejected a $6 billion bid from Roche and likely could have demanded more. While Ion Torrent is a distant second they are growing rapidly. Life Technologies is getting little credit for this product line in its valuation.

What I Like:

- It is very likely that Ion Torrent is worth considerably more than the $725 million LIFE paid for it

- Once one considers the value of Ion Torrent and what free cash flow will look like in a couple of years the valuation on Life Technologies seems attractive.

- Life Technologies will benefit from the secular trend in the aging of the population, biologics, and genetic technology.


What I Don't Like:

- LIFE derives 45% of its revenue from the government and education sector.  I am always hesitant to buy companies where the customers are in trouble.  With bulging deficits, these are not the ideal customers.

- I am going to preface this by saying that I have never met the management of LIFE and did not do much research on them.  For all I know, they might be the most honest people out there.  That said, I always get nervous when a management team comes from GE.  There is nothing scarier than waking up one morning and finding out a company you own has been aggressive in their accounting.  That happens too often with GE management teams.


The bull case on Life Technologies is dependent on the value assigned to Ion Torrent. While I recognize that Ion Torrent is a valuable asset, it is not the type of asset that I typically buy. I am a value investor and Ion Torrent is a growth asset that sells at a growth multiple. Since the upside in the stock is dependent on this asset I will once again pass on Life Technologies.


If you missed them, be sure to also check out previous stock of the week posts:

- Why Steve Romick Owns WellPoint

- Why David Einhorn Owns Dell

Why Steve Romick Owns WellPoint (WLP): Stock of the Week

The stock of the week this time around is WellPoint (WLP) and the analysis below takes a look at some potential reasons as to why Steve Romick of FPA Crescent might like the company. Last week we featured: why David Einhorn owns Dell.


The following is written by Tsachy Mishal, portfolio manager of TAM Capital Management.

Hedge funds as a group have struggled performance-wise in recent years. However, there is one sector which has treated them very well: the HMO's. In 2010, at the height of uncertainty surrounding Obamacare, many hedge funds took positions in HMOs such as UnitedHealth (UNH), Cigna (CI) and WellPoint (WLP).

Since then, most of the stocks in the group are up by 50%, with some nearly doubling. Even after this large rise, many stocks in the the group are still cheap. Currently, Farallon Capital Management and Steve Romick of FPA Crescent hold positions in WellPoint.

WellPoint currently trades at $69.25 a share. They are expected to earn $7.70 in the current year and $8.50 next year. WellPoint is planning on repurchasing $2.5 billion worth of their own shares this year, which amounts to nearly 11% of the shares outstanding at the current price.

The most often cited reason for this bargain basement price is the continued uncertainty surrounding Obamacare. While Obamacare will lead to more customers, there is uncertainty regarding many of the new laws (specifically the mandate that requires them to accept customers at their quoted price, even if they are already sick).

The stock has underperformed its peers in the HMO sector recently as earnings disappointed last quarter. Wellpoint mispriced a large policy in California, which they have since terminated. As a result, Wellpoint trades at a discount to the group, even though it is the second largest HMO in a business where scale matters.


What I Like:

- The valuation of 8.15 times 2013 earnings estimates is extremely attractive assuming estimates are anywhere near accurate.

- Management has an excellent track record of returning cash to shareholders and have said they will return $2.5 billion this year via share repurchases. The share repurchase should put a floor under the stock as there will constantly be a large buyer in the market.

- There is little to no European risk in the business and economic sensitivity is minimal.

- Management recently reiterated their intent to repurchase $2.5 billion worth of shares this year, which likely means that this year is less than a disaster.


What I Don't Like:

- Low health care utilization has helped the earnings of HMOs in recent years. This trend is likely to end at some point.

- Obamacare is a wildcard as it can help or hurt earnings. While there will be more customers there will also be new regulations. This large change is a big uncertainty, which investors don't like.

- A decade ago, HMO industry profits plunged as companies fought for market share. Since then, the industry has consolidated and become more rational. However, there is still the risk that the industry is more cyclical than most believe.


There are numerous risks in WellPoint, such as Obamacare and the risk that margins for the industry contract. However, at a little over 8 times next year's earnings there is a large margin of safety in WLP's stock price. Even if estimates are off by 20% the stock is still cheap. The nice part of the business is that it is insulated from Europe and has little economic sensitivity. As a result, I am long WellPoint.


Be sure to scroll through all of our stock of the week posts for further equity analysis.

Why David Einhorn Owns Dell (DELL): Stock of the Week

Continuing the stock of the week feature here at MarketFolly, this week's focus is on why David Einhorn of hedge fund Greenlight Capital owns Dell (DELL). If you've missed them, be sure to scroll through all the previous stocks of the week.


The following is written by Tsachy Mishal, Portfolio Manager of TAM Capital Management:

If I could only view a single 13-F, it would be David Einhorn's. His long ideas are value oriented, common sense, and simple to understand. In Greenlight Capital's latest investor letter he makes the case for Dell. I excerpted a portion of his argument for Dell below:

"DELL is a large seller of computer and technology products ... While the computer business is mature, DELL has broadened its offerings over the last few years, so that about half its sales and more than half of its gross profits come from other products. DELL has roughly $7 per share in net cash and investments and currently earns about $2 per share (up from $1.50 in 2010). Accordingly, DELL’s P/E multiple is about 7x, and net of the cash and investments, it is less than 4x *(my note: now 5 times due to price appreciation). This reflects a valuation usually associated with collapsing businesses. We expect DELL to continue to grow its earnings per share, albeit at a modest rate."

Greenlight's average purchase price on DELL was $15.53 and shares currently trade around $16.70.

It is difficult to argue with the attractive valuation of Dell at 5 times earnings, net of cash. Although I would make one adjustment to David Einhorn's analysis. The vast majority of the $7 in cash (+investments+short term finance receivables) is either tied up in their financing operation or stuck overseas. Therefore, for valuation purposes I would credit them for a maximum of $6 in cash (and possibly $5 on the more conservative side). Even after this adjustment the company trades for an attractive 5.5 to 6 times earnings and they generate more free cash than earnings.

I view Dell's business as less attractive than David Einhorn does. Even though Dell may no longer be a PC company, it is still largely a boxmaker. A server or storage solution is still a box with other people's hardware components and other people's software.

While Dell has some intellectual property (IP) due to recent acquisitions, they are still largely assembling boxes and loading software onto them. They sell additional services, expertise, and related peripherals with these boxes. I view Dell's assets as: their scale, their relationships with clients, and their trusted brand name. They are trying to transform themselves into more of an IP company but the transformation has risks.

Even though I don't view the business as attractively as does David Einhorn, that does not mean that the business does not have value. Dell probably should trade at a below market multiple but it likely should trade somewhere north of the current 5.5 to 6 times earnings. Customers want to deal with somebody they can trust and Dell has earned that trust; there is value to that.


What I Like:

- Dell is one of the cheapest stocks in the S&P 500, if not the cheapest.

- Dell's business generates more cash than earnings.

- Dell's management is the best operationally of its competitors.

- Dell has strong relationships with its enterprise customers and a trusted brand name.


What I Don't Like:

- Dell is benefiting from a corporate PC upgrade cycle. The server business is likely benefiting somewhat from this as well. Normalized earnings are likely lower than current results.

- I would not be surprised if in ten years enterprise hardware becomes commoditized just as consumer hardware has been.

- Most of Dell's cash is stuck overseas and the valuation is highly dependent on that cash being used wisely.

- Dell only plans to return 10%-30% of free cash to shareholders unless there is a repatriation tax holiday. The amount is even less after one considers employee stock option dilution.

- Dell is planning a transformation via acquisitions. While it could solidify their earnings power, there are risks.


I had a very difficult time deciding whether to purchase Dell or not. It is not the type of business I prefer to own, but the valuation is ridiculously cheap. The fact that they are barely returning cash to shareholders was the deciding factor in not purchasing the shares. At lower prices or if a repatriation holiday became more likely, I would reconsider.

Last month, David Einhorn also provided some comments on Dell in an extensive Q&A session at the CIMA Conference.

For more stock of the week features, head to:

- Why Phil Falcone likes Spectrum Brands

- Why Maverick Capital owns Amdocs

- Why George Soros owns Comverse Technology

- What Carl Icahn sees in WebMD

Why Phil Falcone Likes Spectrum Brands: Stock of the Week

This week's focus stock is Spectrum Brands (SPB) and the article takes a look potentially at why Phil Falcone's hedge fund Harbinger Capital Partners has established such a large position. Previous write-ups include: why Maverick Capital owns Amdocs and why George Soros owns Comverse Technology.


The following is written by Tsachy Mishal, portfolio manager at TAM Capital Management.

The subject of billionaire hedge fund manager Philip Falcone elicits strong feelings. He is best known for his big bet on Lightsquared but lesser known for his other big bet: Spectrum Brands (SPB). Phil Falcone controls over 50% of the $1.65 billion company.

Spectrum Brands is a roll-up of many consumer brands such as Rayovac batteries, Remington shavers, Hot Shot bug killer, Tetra fish food and many more. The largest chunk of the profits comes from the batteries division. Spectrum Brands has had good momentum versus its peers as their discount brands tend to gain market share during difficult economic times.

SPB has a $3.35 billion enterprise value and a $1.65 billion market cap. On an enterprise value to EBIDTA basis, Spectrum Brands trades at an 11% discount to peers based on 2013 expectations. This does not even take into consideration the $1.2 billion net operating loss carry forwards (NOLs) they hold.

What I Like:

- Spectrum's stock has 23% upside before trading at the valuation of its peers, even ignoring the NOL's.
- The businesses have positive momentum and are gaining share. Consumers are likely to continue shifting towards lower price brands.
- Spectrum Brands has a greater than 12% free cash flow yield based on 2012 expectations.
- The controlling shareholder seems to have his incentives aligned with the best interests of other shareholders.


What I Don't Like:

- The company is carrying a lot of debt.
- The business is cyclical both from an economic perspective and a market share perspective.
- The stock is illiquid as a few owner's control 70% of the company. Fewer than 200k shares trade a day on average.
- Phil Falcone does not seem to have the highest ethical standards as he borrowed money from his hedge fund while locking up other investors.


The valuation of Spectrum Brands is attractive compared to its peers and is the most tempting aspect of the stock. I suspect that it will outperform but in the end I decided not take a position due to the negative factors I listed.

---

Thanks to Tsachy for the write-up. We've also highlighted how Harbinger has been buying SPB shares recently. The hedge fund originally acquired shares back in August 2009 when the company emerged from reorganization (Chapter 11).

At a past investment conference, Falcone has previously stated that he likes Spectrum Brands' solid balance sheet, high 11-12% free cashflow yield, and the fact that the company had been focused on debt paydown by reducing leverage from 3.5x to 3x.


You can scroll through all of the previous stock of the week articles via this link.

Why Maverick Capital Owns Amdocs (DOX): Stock of the Week

Continuing the stock of the week series, this time around the focus is on why Lee Ainslie's hedge fund Maverick Capital owns Amdocs (DOX). If you missed last week's, be sure to also check out why George Soros owns Comverse Technology.

The following is written by Tsachy Mishal, portfolio manager of TAM Capital Management:

It often happens that when owning a company, I stumble across one of their competitors or another company in their industry and end up owning them as well. I came across Amdocs (DOX) when researching last week's stock of the week, Comverse Technology (CMVT) as they are competitors. Amdocs is a large position for tiger cub Lee Ainslie's Maverick Capital.

Amdocs makes billing and customer relationship software for telecom companies. They are the leader in their industry with 28% market share, three times the share of their closest competitor. Amdocs generally signs 5 to 8 year contracts with their customers so revenue visibility is high. These long term contracts account for 75%-80% of their business.

DOX trades at less than 10 times this year's expected free cash flow and less than nine times next year's (EV/FCF). Profit growth is expected to be in the mid single digits but with share repurchases EPS growth is expected in the mid teens.

What I Like:

- The valuation is very attractive for a company with such high earnings visibility.
- Amdocs repurchased approximately 10% of their shares outstanding last year and is set to do the same again this year.
- No major contracts are set to renew until 2014, making visibility especially good for the next 2 years.
- There are high switching costs to move to a competitor.
- Amdocs is by far the leader in the industry.


What I Don't Like:

- A single customer, AT&T, accounts for 29% of revenue.
- The business is tied to a single industry, albeit a good one.

I originally looked at Amdocs in order to get a comp for Comverse Technology (previous analysis here) but after studying the company I had little choice but to buy a position in it. A market leading company, with high visibility, that is returning cash to shareholders should not be trading at a single digit multiple (EV/FCF).

For past stock of the week entries, check out why Carl Icahn owns WebMD and why George Soros owns Comverse Technology.

Why George Soros Owns Comverse Technology (CMVT): Stock of the Week

Continuing our new feature at Market Folly, today's stock of the week focuses on why George Soros' family office owns Comverse Technology (CMVT). If you missed the inaugural stock of the week, be sure to check out why Carl Icahn bought WebMD (WBMD) as well.



The following is written by Tsachy Mishal, Portfolio Manager at TAM Capital Management. He provides background on the situation, as well as what he likes and dislikes about the company:

Comverse Technology (CMVT) was involved in an accounting saga that dragged on for years and cost well over a billion dollars to untangle. During that period, a who's who of hedge funds tried to catch the CMVT falling knife unsuccessfully. Currently, Soros Fund Management and Barry Rosenstein's Jana Partners own major stakes in Comverse.

There has recently been progress as Comverse's financials are up to date and Comverse announced plans to separate their businesses with a spinoff of their Comverse unit. After the spin-off, shareholders will own the Comverse operating business and eventually shares in Verint (VRNT). The full details are not yet available as they are trying to structure this in a tax efficient manner and are still in discussions with the IRS on exactly how to do this.

Comverse trades with a market cap of $1.356 billion. They own $755 million worth of shares in Verint, a publicly traded company. They have $393 million in cash on hand at the Comverse operating unit. They own a 65% interest in Starholme, which at a conservative valuation is worth $45 million. Once one removes these items, the Comverse business is being valued at $162 million:

Comverse market cap @ 6.22 a share: $1,356 million
less value of Verint shares @ $27.98 a share: -$755 million
less cash on hand at Comverse operating unit: -$393 million
less 65% stake in Starholme: -$45 million

equals implied value of Comverse operating unit = $162 million


Comverse creates billing software for telecom companies. The most comparable company is Amdocs (DOX), which trades at a very conservative valuation of 1.5 times revenue. Comverse has revenue of $700 million, which means that at Amdocs valuation Comverse would be worth $1.05 billion. That is a far cry from the current $162 million the market is currently valuing Comverse.

Comverse management is guiding to 10% operating margins, which means net margins will likely be 10%, as Comverse has billions of dollars worth of NOLs. Amdocs has net margins of 13%. On this basis Comverse should be worth about $800 million, still a far cry from from the $162 million the market is currently assigning it.


What I Like

- Owning a software company that is cash flow positive with revenue of $700 million and 10% margins for $162 million seems like a no-brainer.

- There are high switching costs, so Comverse is likely to retain its customers. This predictable revenue stream might make it attractive to private equity or a competitor that could squeeze out better margins.

- Given all the distractions, it's very likely that Comverse is being under-managed and there is room for operational improvement.

- The bad actors have been removed from the board and the new board seems to be acting in the best interest of shareholders.

- I believe that Verint shares are undervalued as they trade at 11 times current fiscal year free cash flow estimates and nine times next year's estimate. This is for a fast growing small cap software company. Part of this discount likely has to do with their association with Comverse. A clean split could be a catalyst for a better valuation.


What I Don't Like

- Comverse does not have separate financials for its Comverse unit as a standalone company. One has to trust management on the 10% margin number.

- For years Comverse has seemed one step away from putting the fiasco behind them, yet the end has always been elusive. The spin-off is supposed to happen in the second half of the year, but this is not over until it actually occurs.

- There is a level of complexity to the investment as there are quite a few parts. One cannot simply buy the Comverse operating business.

I recently purchased shares in Comverse, albeit a smaller position than I normally purchase. It is difficult for me to see how one loses at the current valuation, although I'm certain that's what the hedge funds that have fallen before me in this stock thought. The difference is that the financials are now up to date and an end is in sight. The complexity of the situation and the history have me cautious and are the reason I have taken a smaller than usual position.

The above was a contribution by Tsachy Mishal, Portfolio Manager at TAM Capital Management.


Stay tuned for a new stock of the week in seven days. If you missed it, be sure to also check out why Carl Icahn owns WebMD (WBMD).

What Carl Icahn Sees in WebMD: Stock of the Week

We're proud to announce a new series here on MarketFolly.com: stock of the week. This series aims to provide a quick summary of what hedge fund managers and well known investors might see in a particular company.

These posts are written by Tsachy Mishal who is the Portfolio Manager at TAM Capital Management. He provides background on the situation, as well as what he likes and dislikes about the company. Here's his take on what Carl Icahn sees in WebMD (WBMD):


Carl Icahn is so well known for putting fear in the heart of corporate boards and entrenched managements everywhere, that his amazing record as an investor is often overshadowed. When I saw WebMD trading at a 52 week low I was eager to take a look as Carl Icahn bought 11.64% of the company at significantly higher prices.

WebMD is the most visited health related website in the US by both patients and doctors. People visit the site in order to learn more about drugs, illnesses, and general health issues. WebMD largely makes its money off of advertising. WebMD has stumbled recently as pharmaceutical companies have cut ad spending. Pharmaceutical companies are facing a patent cliff which is a double whammy for ad spending. There are fewer drugs to advertise and companies are looking to offset lost revenue with lower costs.

WebMD has a market cap of $1.4 billion and $320 million in net cash for an enterprise value of $1.08 billion. In 2011 WebMD produced $558 million in revenue and $116 million in free cash flow. In 2012 revenue is expected to fall to $507 million and free cash flow is expected to fall to $65 million.

What I like:

- WebMD trades at a little over 9 times 2011 free cash flows. If they could turn around their revenue decline and cut costs, the stock would be very attractively priced.

- Carl Icahn seems to be influencing the company as the recent tender offer is straight out of his playbook.

- There is a tender offer for $150 million worth of shares. Tender offers tend to have a positive short term effect on stock prices.


What I don't like:

- WebMD trades at 16 times forward free cash flow, which seems high for a stumbling company.

- Stock option expense is nearly $40 million a year, which is a very large portion of free cash flow and earnings.

- Content creation on the internet does not have any barriers to entry.

- There do not seem to be any potential acquirers as the company unsuccessfully tried to sell itself recently.

I must admit to scratching my head when first looking at the company, trying to figure out what Carl Icahn sees. Then, I realized that just a few months ago there were expectations for growing revenue and free cash flow. I'm not certain that Carl Icahn would have gotten himself into this situation had he known he was looking at a revenue and free cash flow decline. However, as owner of 11.6% of the company, it's difficult for him to turn back. WebMD is now a turnaround situation and with Carl Icahn calling the shots I wouldn't bet against them. That said, I'm not interested in betting alongside Carl Icahn in WebMD.


That concludes the first entry in MarketFolly's new series: stock of the week. The above was written by Tsachy Mishal, Portfolio Manager at TAM Capital Management.