Special Situation Investing

Etrade Canada Venting

2007-04-21T09:05:00.000-07:00

Well just looked at my latest transaction from Etrade Canada and man am I pissed. I usually trade in American dollars so I haven't really noticed this before but the company is charging very excessive rates on my trades. I bought stocks yesterday when the exchange ratio was in the 1.12-1.125 CAD per USD range. Great. Etrade, however, actually ended up using an exchange ratio of closer to 1.143 on my purchase. That amounts to a ~2% grab just on the exchange ratio! That is huge! Consider that you will also pay ~2% on the way out as well. It makes it completely impossible to own stocks for anything less than years. A cigar butt with a 30% gain isnt' even worth your time as after Etrade takes it's bite you only have 26%.

I think these fees are excessive, swept under the mats and frankly I'm looking for a new online broker. IF anyone knows of one that doesn't charge massive exchange rates, let me know.

State Street Financial (SSFC) - Going Private Transaction

2007-03-24T11:42:00.000-07:00

Well it's now official. After a shareholder vote, SSFC will be repurchasing from shareholders with fewer than 750 shares for $10 a pop. The stock closed around $8.60. I obviously didn't get rich off of this one but it was low risk and a high rate of return relative to the time I was invested.

More details on SSFC here.

Temple-Inland (TIN) - Split-up Announced

2007-03-24T11:35:00.000-07:00

After prompting by Carl Icahn, Temple-Inland (TIN) has announced that they will be splitting up by year's end.

The forest-products company said Feb. 26 that it plans to split into three public companies and sell its timberlands by year-end.

...

But Jastrow is willing now to spin-off his company's financial services and real estate operations while keeping its manufacturing operations, which include packaging and building products. "Each of the three public companies - manufacturing, financial services and real estate - will be well positioned in the marketplace, have an appropriate capital structure and will benefit from greater strategic focus," Jastrow said in the release.

Buffet - Words of Wisdom

2007-02-27T20:52:00.000-08:00

Thought this quote was rather appropriate on a day like today.

"Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market."

Warren Buffet

Let's get back to the market. Nothing has fundamentally changed in my view. So Chinese banks can't loan out quite as much money. This was announced in advance, I remember reading it. I mean let's think about what is happening here. The Chinese government is taking steps to temper growth and prevent recession. What is wrong with that? Would the market have preferred if they let the train run off the tracks? When I read about the major recessions in Japan and in the US it seems one of the biggest problems was the government stood idly by. China may or may not hit a recession but long-term I view the current situation as a positive. The biggest risks when investing in China are political not economic in my view.

Somebody had a run at Cheney? How is that different from any other day? Don't get me wrong, I feel the situation is horrible and I really do have sympathy for those who lost their lives in the attacks. However, I also have sympathy for those who have lost their lives in all the prior suicide bombings that the market completely ignored. I don't see what the difference between today and any other day was.

Greenspan thinks there might be a US recession. He says the bull market is long in the tooth. Jesus christ, is this not something people could have figured out for themselves? Is he doing anything other than validating what anyone who went through the last bubble/crash is already thinking?

I don't know what is going to happen tomorrow or even this year but staring at these long rows of red I can't help thinking that maybe, finally prices are going to get back to levels where I can really start buying again.

Travelcenters of America (TA) - Spunoff from Hospitality Properties Trust (HPT)

2007-02-25T17:02:00.000-08:00

Found an excellent post detailing the spinoff of Travelcenters of America (TA) from Hospitality Properties Trust (HPT). Unfortunately, I am already over a month late on this one and it has seen a tremendous surge from $28-29 to over $38 on Friday. Still worth watching, analyzing and potentially buying. I don't have time right now but I'll get back to this one. For now, check out the post link above.

Update

A reader posted a comment to this entry and I thought it deserved inclusion.

An excellent post?? It's an awful post. It doesn't detail the huge lease commitments to HPT (+$150MM/pa and rising)and fools you into thinking there's "no debt". It doesn't detail the onerous restrictions HPT placed on TA (like that HPT has to finance every deal and has right of first refusal everywhere), doesn't discuss all the insider conflicts, doesnt say what happens when the lease expires. And the low multiples referred to are not substantiated. There's no company guidance and limited historical info. Read the S1, it's impossible to conclude what normalized cash flow is without making stupid assupmtions, like basing multi year forecasts on one nine month period. Stock is up from all the folks who read the blog and bought the stock without doing homework. I'm not short TA and am not even saying that it's necessarily a bad idea but I am saying that there's a lot more to the story including a lot of negative stuff and that it is not as cheap as Harper makes it out to be. Read Feb20 Wall Street Journal article "TravelCenters Aims to Please--Its Ex Owners" and of course read the S1--
http://www.financials.com/custom/cbig/filing.cfm?filingid=1382&csymbol=TA

This reader does have a point. I try to post references to all spinoffs I come across, good or bad, and if you've read my blog you'll know that I think most are bad. After having a chance to review (briefly) the situation I would have to agree that the initial writeup didn't cover all of the issues. Reviewing the S1, there are a number of issues, highlighted by the reader above, that do need to be addressed. Honestly, I just don't have time right now to really crunch all the numbers out but I have extracted some of the more relevant data from the S1. I highly recommend you go through the S1 yourself to reach a decisive conclusion.

From the S1.

We were formed for the benefit of Hospitality Trust and not for our own benefit. Our formation allows Hospitality Trust to acquire and retain ownership of 146 travel centers without adverse tax consequences to Hospitlity Trust. Because we were formed to benefit Hospitality Trust, some of our contractual relationships and the terms of our initial business operations may provide more benefits to Hospitality Trust than to us.

...

Our creation was, and our continuing business will be, subject to conflicts of interest, as follows:

•: Two of our directors were trustees of Hospitality Trust at the time we were created.
•: Upon completion of the spin off we will have five directors, one of whom, Mr. Barry Portnoy, also will be a trustee of Hospitality Trust and the majority owner of Reit Management, one of whom, Mr. Arthur G. Koumantzelis, is a former trustee of Hospitality Trust, and one of whom, Mr. Thomas O'Brien, is a former executive officer of Hospitality Trust.
•: Mr. O'Brien who will be active in our senior management activities is also an employee of Reit Management. Another Reit Management employee, John R. Hoadley, is our treasurer and will also be active in our senior management activities. Reit Management is the manager for Hospitality Trust and we will purchase various services from Reit Management pursuant to a management and shared services agreement.

These conflicts may have caused, and in the future may cause, adverse effects on our business, including:

•: Our lease with Hospitality Trust may be on terms less favorable to us than leases we could have entered as a result of arm's length negotiations.
•: The terms of our management and shared services agreement with Reit Management may be less favorable to us than we could have achieved on an arm's length basis; specifically, our payments to Reit Management of 0.6% of our fuel gross margin and 0.6% of our total non-fuel revenues for shared services, equal to $4.7 million on a pro forma basis for the nine months ended September 30, 2006, may be greater than if these services were purchased from third parties.
•: Future business dealings between us and Hospitality Trust, Reit Management and their affiliates may be on terms less favorable to us than we could achieve on an arm's length basis.
•: We may have to compete with Hospitality Trust, Reit Management and their affiliates for the time and attention of Messrs. Portnoy, O'Brien and Hoadley

...

Minimum Rent. The lease requires us to pay minimum rent to Hospitality Trust as follows:

Lease Year	Annual Rent (000s)		Per Month (000s)
1	$	153,500	$	12,792
2		157,000		13,083
3		161,000		13,417
4		165,000		13,750
5		170,000		14,167
Thereafter		175,000		14,583

In addition, minimum rents may increase if Hospitality Trust funds or reimburses the cost of renovations, improvements and equipment related to the leased travel centers as described below.

Improvements. Hospitality Trust has agreed to provide up to $25 million of funding annually for the first five years of the lease for certain specified improvements to the leased properties. This funding is cumulative, meaning if some portion of the $25 million is not spent in one year it may be drawn by us from Hospitality Trust in subsequent years; provided, however, the entire $125 million of funding must be drawn before December 31, 2015. All improvements will be owned by Hospitality Trust. There will be no adjustment in our minimum rent as these amounts are funded by Hospitality Trust.

...

Income from operations. Our predecessor generated income from operations of $74.3 million for the nine month period ended September 30, 2006, compared to income from operations of $77.2 million for the same period in 2005. This decrease of $2.9 million, or 3.8%, as compared to the 2005 period was primarily the result of the $11.9 million increase in share based compensation expense in the 2006 period. The effect of increased share based compensation expense was somewhat offset by the $4.4 million expense reduction related to claims settlements and the increased gross profit that resulted from increased fuel and non-fuel sales volumes and fuel margins per gallon.

Goldman Sachs (GS) - Portfolio Insurance Puts

2007-02-20T10:24:00.000-08:00

I can't help feeling increasingly nervous as the major indexes continue their ascent. While we are certainly not seeing the degree of optimism in the 99/00 bubble it does seem that the markets are warming up to the idea of prosperity. I however, have my doubts. Now I don't want to be one of those fire and brimstone perma-bulls who is constantly predicting the end. However, I feel there is a realistic and poorly discounted chance that the economy will hit a snag or worse.

It could be housing, consumer debt, depreciation of the dollar, or some unforseen series of events. I really just don't know. However, I am not willing to continue to hold the overwhelming bulk of my net worth long in equities.

As such, I have decided to purchase some puts to offset the risk. I don't normally condone hedging as I feel it generally just diminishes results. However, the risk premium on certain companies is sufficiently low that it seems like a good bet. Today, for instance, I bought $180 Jan/08 puts on Goldman Sachs (GS) for $5.50 an option. For those new to options, what this means is that for $5.50 a share I have the right to sell GS for $180 up until the third friday of January 2008. Of course, this only makes sense if GS dips below $180 over the next year, otherwise the position is a complete loss.

Let me give you an example. If the stock price were to descend to say $150, well you could buy the shares for $150 and sell them for $180, providing a $30 spread. Given that you bought the options for $5.50 and generated $30 from the trade, this scenario would provide a 445% profit. It is more complicted than this as the options are worth more than the spread based on the amount of time remaining before expiration. Also, you don't actually need to do the buying and selling of the shares, you can just sell the options and let someone else worry about it.

Back to Goldman. If you don't know, Goldman Sachs is probably the preeminent investment bank of the world. As the number of IPO's and leveraged buy outs have surged, GS has benefitted. They also operate significant internal trading operations which have generated substantial profits lately. Over the last few years I have watched their stock price explode from the $80-90 range in 2004 to over $220 at the time I sit writing this.

Now I am not saying that GS is not a good company. I actually think it is an excellent firm with a strong reputation and I would never short the stock. However, it is highly leveraged to the success and failure of the stock market. Should things turn south, Goldman will feel the pain and in amounts proportionately higher than the rest of the market. There is also, always the small chance of failure of some magnitude by it's investment division even in an up market. Look at the demise of Amaranth for example. I have heard many good things about GS's investments, how they always seem one step ahead of the market and the massive amounts of profit they generate. I am skeptical. People make mistakes, computer models have flaws and limitations, six-sigma events DO happen in the market.

I should mention that the options I have purchased represent a VERY small proportion of my portfolio. Roughly 0.5% of my net stock holdings. So I can afford to take a complete loss on the thing and it would just be a marginal tick off my gains for the year. However, in a nasty market, one where the stock market gets hit 20-30% I can envision turning a profit of 5-15x my investment, thereby buffering my other losses.

Halliburton (HAL) - Spinoff of KBR Unit Continued

2007-02-18T21:43:00.000-08:00

I did a bit more digging on the specifics of the KBR spinoff from HAL. The initial IPO of KBR stock represent approx 19% of outstanding stock. The remaining portion will be distributed by Halliburton to existing shareholders, hopefully via a spinoff. KBR currently has a market cap of $3.74 B which includes the 81% ownership by HAL. As such, ~$3 B of HAL's market cap is attributable to it's KBR stock. Excluding that $3 B from HAL's market cap of $30 B gives a rough value of $27 B for HAL post-KBR.

So you could say that the market is valuing HAL's energy services group at $27 B. Energy services provided $3.4 B operating income in 2006 and $2.3 B in 2005. This was generated from $13B revenue in 2006 vs $10B in 2005. Interest expense was nominal and largely counterbalanced by interest income. Taxes take roughly 1/3 of profits. This leaves us with $2.3 B or so net income from the energy group against the $27B market cap and provides for a P/E of less than 12. The unit is likely to grow at least in the short-term as demand for it's services continues. The oil majors, especially Exxon (XOM), have been holding back on oil exploration until the last couple years after being burnt by previous oil rallies. This is starting to change, as confidence that oil will remain high historically builds and as the majors struggle to maintain existing production. The company also has decent geographic diversity with ~55% of revenue coming from outside North America.

What you need to keep in mind, however, is that in the long-run if the price of oil were to fall the majors eventually would scale back their exploration and development projects. Have a look at it's five year chart to see how much it has surged with the price of oil.

Theoretically, KBR should be the asset of choice in this transaction. It is significantly smaller than HAL ($3.7 B against $27 B), it is hated, it's dependance on government contracts make revenue and earnings unpredictable, and it is in a different sector than HAL. By all rights, this stock should get pounded after the spinoff occurs. You would think that most HAL owners would just love to get rid of the stock and associated bad memories. We will see if that happens. Personally, I would only be a buyer of KBR if it got absolutely nailed as at present I am not particularly interested in this type of business, I don't see much competitive advantage and god only know what it's future revenue will be like. In other words, it legitimately might be a bad buy and needs a greater discount for me to purchase. Consider that it IPO'd at $17 and currently trades for $22.88 so it is already considerably higher than initially valued by it's owners.

HAL is not the only cheap oil services company either, Baker Hughes (BHI) goes for about 13x forward estimates and Schlumberger (SLB) for about 13.5 x forward earnings. So yes it is cheaper than it's competitors but then again it has lower margins than them as well.

On the flip side, I'll just throw in that George Soros bought some 1.9 million shares in HAL during the past quarter.

What it comes down to is your perception of where oil prices are headed. They don't need to surge upwards for HAL to be a good buy, even if the market could maintain present prices for awhile you could see upward pressure on the stock. However, I already have energy exposure and quite frankly I think Schlumberger is a superior company to HAL. I will keep an eye on the price of KBR and may take advantage of any selloff's that occur post spinoff.

If you are still interested in HAL, check out the fourth quarter results here.

Halliburton (HAL) - Spinoff of KBR Unit

2007-02-17T20:35:00.000-08:00

While not exactly recent news, I thought it was worth mentioning that Halliburton (HAL) is planning to spinoff it's engineering and goverment services division, KBR, this April. KBR stock was initially floated in November with the bulk of the shares to be distributed via the April spinoff. The KBR unit has been plagued by negative publicity and investigations into the allocations of government contracts. The division's reliance on the distribution of government contracts, which can produce very lumpy results, also limits the earnings multiple. No doubt, HAL is hoping that a spinoff will allow it's oil services section to receive a higher valuation level with little impact on the value of KBR.

At first glance this appears to be a compelling spinoff situation. Halliburton plays a prominent role in a booming albeit highly cyclical industry. One of the limiting factors in oil exploration and development, in fact, is the rising cost of the enabling technologies provided by Halliburton amongst others.

I plan to do more analysis on the specifics over the next few days with a more detailed post to follow. In the meanwhile, if anybody has any comments on the spinoff I would appreciate hearing them.

Time Warner Cable (TWC) - Cleared for Trading

2007-02-13T10:09:00.000-08:00

Time Warner Cable has cleared regulatory hurdles and should begin trading as a separate company (TWC) on March 1. As the name suggests, TWC is majority owned by Time Warner (TWX) and represents assets purchased from bankrupt Adelphia.

Even after becoming public, the company will still be majority owned and controlled by its parent company Time Warner Inc
..
Time Warner Cable will distribute 156 million shares of its stock, or about 16 percent of its total outstanding shares, to stakeholders in Adelphia. That stake is valued at approximately $6 billion
..
Time Warner Cable's shares have been trading on a temporary or "when-issued" basis on the New York Stock Exchange since early this year under the symbol "TWCAV." Those shares slipped 25 cents to $40.75 in midday trading.

Webzen (WZEN) - Distribution Agreement

2007-02-12T16:34:00.000-08:00

Korean online game developer Webzen (WZEN) has signed an agreement with The9 to distribute it's new release Huxley, in China. WZEN surged over 9% on the news.

The total projected amount of the agreement for Huxley’s distribution and service rights is estimated at $35 million. This includes the down payment and a minimum guarantee for a three-year period, while the royalty rate is set at 22% for the duration of the contracted term. The agreement covers the PC version of the game.

To put things into scope, China is only 1 of many markets and the company has several other products in-use and under development. As such I don't know that this is as significant an event as the price change would indicate. Then again, I've believed in Webzen for awhile, having previously purchased shares. What I am hoping, what I have seen in the past, is that the company will continue to get it's new games out and press releases like this will continue to print. However, having seen it 20% lower I see no reason to add to my position and will just hold my existing shares.

Asset Acceptance Capital Corp (AACC)

2007-02-12T16:11:00.000-08:00

A reader of this blog wrote in with a fairly detailed description of a company he is tracking. While it isn't really a special situation there is no point in letting his analysis go to waste.

I'm not sure if it qualifies as a special situation though, Asset Acceptance Capital Corp (AACC). It buys unpaid consumer debt, mostly credit cards, and collects on them using call centers and legal filings. It has a number of publicly traded competitors (PRAA, ASFI, FCFC, ECPG). People generally seem to think that PRAA is the class of the industry, but it trades at a higher valuation. AACC has a 52 week range of 14-21.4 and is currently trading at 15.73.

The sector in general has been battered because the price paid for debt has been going up as more players have gotten involved in the industry. AACC in the latest quarter said their cost to acquire debt has gone to 3.54 from 2.49 cents on the dollar in the previous year. AACC earned 10.7 million or .29 cents a share as opposed to 13.7 million (37 cents a share) the year before. Cash collections increased 3.5% from the previous quarter, but revenues decreased due to lower expected returns on their portfolio and a 6.3 million dollar impairment charge.

AACC like most of the industry uses the IRR method of accounting where they assign an estimated internal rate of return to each purchased collections portfolio and any amount collected above the IRR is applied towards the principal of the portfolios. If revised cash flow estimates don't meet the IRR an impairment is taken, but the IRR remains unchanged. This adds lumpiness to earnings as portfolios are marked down instead of just earning a lower rate of return over time (for accounting purposes).

Asset Acceptance have 320 million in tangible assets and 76 million in tangible liabilities (58 million of which is a deferred tax liability) with no debt. This gives them a tangible book of 244 million or 2.4 times their market cap of 588 million. They have earned roughly 0.30 the last three quarters and would have earned $0.40 cents in the 4th quarter of 2005 if it wasn't for a very large write down they took on a newly acquired portfolio of wireless bills (an asset class they had just ventured into). Their earnings have been declining in 2006, and their returns on capital have been declining for a long time due to increased competition.

I think the real question about this industry is should they be trading at a premium to their tangible book value and if so how much? The answer to the first question is clearly yes, because it takes knowledge, organization and experience to collect a portfolio of receivables. AACC has a table in their 10-K that shows account executives who have a year or more experience are 50% more effective than their less experienced co-workers. The second question is much trickier. The lack of debt on AACC's books give it some leeway when in comes to maintaining earnings in the face of declining returns on assets. They could borrow money, buy back stock and maintain their current level of earnings if industry ROA's where to decline somewhat. Also, at some point the industry becomes unattractive for new competitors to enter it.

At this point my thinking on the situation becomes more nebulous. On the one I don't think there are particularly steep barriers to entry to get into the industry. On the other hand I don't think it's an industry that the best and brightest of America's business schools are clamoring to get into. I don't think there is a lot of glory of it. I think this probably keeps the level of competition down and smart talented people in the industry can do reasonably well. This brings me to the question of why AACC as opposed to the other companies in the industry. The answer to this is that I found their financials to be well organized and straight forward with lots of useful information that an owner (stockholder) of the business might want to know. Their competitors financials I found less well organized and presented (I didn't look closely at PRAA because of its status of industry darling). One of their competitors had much higher ROE's but buried in its financials was the disclosure that it sold most of the receivables for big gains without actually collecting them (this strategy won't work if receivable prices don't keep increasing).

MY REVISED THINKING:

Most of AACC reported earnings come from receivable portfolios that were acquired at much lower prices 1-2 years ago. In their latest quarter they reported that they invested 27 million in new receivables the same as last year. However they only expect to have 53 million in revenue from this portfolio as opposed to 70 million from the one purchased in 2005. A significant decline in revenue with collection expenses staying constant/rising is going to cause a dramatic drop in earnings. Yes they can use leverage to make up for some of this, but I don't think their going to be able to borrow at rates that are all that great. I think I will look at this company again 1-2 years from now. It might be interesting then. At some point they will be reporting really ugly earnings, but probably have a lot of earnings power going forward due to a drop in the purchase price of unpaid debt. Then will be the time to strike. I'm glad I composed this e-mail so I can get out. Hmm..it might be a short opportunity.

...

You should probably note though that on Monday I am selling my long position in AACC and possibly getting short.

Bayard

I will keep watching this one. I have to agree that it's lack of coverage may be keeping it's pricing down. That in addition to it's un-glamorous industry are characteristics that tend to make for good investments.

Thanks for the post Bayard!

Western Union (WU) - Article Link

2007-02-11T08:30:00.000-08:00

Motley Fool has a good and most importantly, free, article on Western Union. The article attempts to analyze the company from a value perspective but along the way makes some good points on growth :

Management noted it still only has 17.4% of the $269 billion global cross-border remittance (sending money internationally) market, and it captured about 7.4 points of that in the past three years -- indicating that a lot of share is still up for grabs.

...

International business has grown 26% annually since 2001, and China grew over 30% in 2006.

I bought some shares in Western Union a couple of weeks ago.

Spinoff Tracker Index - Rebuttal

2007-02-09T15:45:00.000-08:00

One of my main priorities in investing is to always stay level-headed and unbiased. As such, I wanted to pass on an email I received in regards to my previous post on a spinoff tracker index. The author makes a number of good points so I will allow you to decide for yourself the merits of the index.

Matt,

I felt I should write you after reading your post on our index.

We have licensed the index to Claymore who has issued the ETF symbol:
(CSD).

Our methodology is more quantitative than qualitative and followed some of the knowledge gained from research performed before we created the first investable spin-off index.

Specifically:

Academic

Penn State University: Cusatis et al., 1993

Purdue University: McConnell et al., 2004

Wall Street/Consultant research

McKinsey: Anslinger et al., 1999

Goldman Sachs: Stelmach et al., 2006

Lehman Brothers: Dickson et al., 2006

Our back-tests did not data mine and took into account certain survivor biases. We feel our work was sound and I personally invested in the Claymore/Clear Spin-Off ETF on its opening day.

Please feel free to contact me if you would like more details. Our site is reasonably complete and I am blogging on many of the constituents.

Best regards,
Andrew Corn
CEO
Clear Indexes LLC
Blog: www.ClearAMIdeas.com

Weyerhauser (WY) - Initiates Domtar spinoff/stock exchange

2007-02-09T10:02:00.000-08:00

Weyerhauser (WY) has initiated it's Domtar stock exchange program, which implements the spinoff of their fine paper division:

Under the terms of the offer, participating Weyerhaeuser shareholders will receive approximately $1.11 worth of Domtar Corporation common stock for each $1 of Weyerhaeuser shares tendered in the exchange offer, subject to a limit of 11.1442 shares of Domtar Corporation common stock per Weyerhaeuser share. The value of Weyerhaeuser shares and Domtar Corporation common stock will be calculated using the simple arithmetic averages of the daily volume-weighted average prices (VWAP) of Weyerhaeuser common shares and common shares of Domtar Inc., respectively, on the New York Stock Exchange on the last three trading days of the offer, unless the offer is subject to the mandatory extension described below.

Keep in mind that if the offer is over-subscribed, you are not guaranteed to fully exchange your Weyerhaeuser shares for Domtar.

Weyerhauser also announced earnings today.

Weyerhaeuser Company (NYSE: WY - News) today reported net earnings of $395 million for 2006, or $1.61 per diluted share, on net sales of $21.9 billion. This compares with net earnings of $733 million, or $2.98 per diluted share, on net sales of $22 billion for 2005.

Excluding one-time items, earnings were only .68.

It is also worth noting that the company repurchased 5.5 million shares of stock during the past quarter. WY has ~240 million shares outstanding.

I originally posted about the WY spinoff of it's fine paper division here.

Update

Did just a bit more digging and I have figured out a few more pieces of the WY spinoff puzzle.

If you are interested in the nitty-gritty of the transaction, click here, if you accept their agreement, in the following screen click on the prospectus link.

At present WY expects 281 million shares of Domtar will be available for exchange. As previously mentioned the company is offering to convert WY shares to DTC at a maximum rate of ~$1.11 worth of DTC for each $1 of WY. For the price to use in setting the exchange rates, they are using the values of DTC & WY averaged over a 3 day period at the end of February - beginning of March. WY estimates the maximum number of shares of WY they would accept for the ~281 million DTC shares is ~25 million. WY has ~240 million shares outstanding. So at most 10.5% or so of their outstanding shares could be converted to Domtar.

To add another twist, their is a possible delay added to the deal. If it over-subscribed, that is if there are more shares offered than are available for trade, there will be a 2-day delay added. During this period those shareholders who offered their shares may either transfer at the adjusted exchange rate or not transfer at all.

Unless you hold an amount less than 100 shares, WY will apply prorationing to the subscription. What this means, I believe, is that even if you submitted 100 shares you may only be allowed to convert a portion of them to Domtar shares. For instance, the company may only accept 50% of those shares if the offer is 100% over-subscribed, or 25% of the shares if the offer is 300% oversubscribed. The remaining fraction of the shares are returned to the shareholders. However, if you own less than 100 shares you can request not to be subjected to prorationing. It appears that this is a case where small investors may have an advantage. You can submit up to 99 shares and then, based on the closing prices, be relatively confident of making a gain, over the averaged prices in those 3 crucial days. Of course, if the stocks were to move significantly before the calculation or after, if the spread between WY and Domtar was to exceed the maximum 11.1442 maximum ratio of shares exchangable, the gains coud be reduced or even turn into losses but it still sounds appealing.

I am going to keep digging into this one.

Incremental Update

2007-02-08T17:56:00.000-08:00

United Parcel Service (UPS) announced plans to increase it's quarterly dividend by 4 cents (~10%) to .42, and upped it's buyback limit to $2 billion. For reference, the company currently has a market cap of ~$78 Billion, and a share price at $73.33. I purchased shares in UPS about a week ago.

Philip Morris, majority owned by Altria (MO) increased the price of certain cartons of cigarrettes by $1.99 today. Also today, competitor Reynolds American (RAI) saw a slip in earnings as excessive shipments in the previous quarter and higher promotional expenses cut into profits. After the slip, Reynolds trades at 15.3 times past earnings. This is very comparable to MO's current valuation, post-Kraft. Excellent article over here, with the goods on Altria's future prospects.

A Few Things

2007-02-07T16:16:00.000-08:00

Tyco dropped .62 today, to $31.97. Even though I own shares, I can't help enjoying this as I would really like to put some more money into the thing. Really, the more I think about it the more I like it. Let's just see the price get down a little further.

Decent article over here about a turn-around in progress at RadioShack. My problem with this one is that the company's revenue to market cap is already pretty high at .7 or so. Walmart, in comparison, has a rev/market cap of .65. So it's priced high and we're still in the opening innings of the turn-around. Not going to bite at this one.

Good top-10 list here of some value stocks. The thing I like about this one is that there is an explanation of why each stock is a buy.

Tyco (TYC) Spinoff

2007-02-06T16:02:00.000-08:00

I have posted about it before, but just a note that Tyco released it's results a few days ago, and announced that the breakup of the company should be happening in April. Tyco is a conglomerate and fallen angel, both of which make for a good spinoff. By splitting apart related businesses, ideally the businesses should prosper under intensified management scrutiny. Also, by splitting up, perhaps some of the bad-will left over from the previous CEO's corruption can finally be put to rest.

The company will be split into 3 new companies: 1) health care, 2) electronics and 3) engineered and safety products. Breen, the current CEO, will take over the engineering/safety business. This in itself is admirable as his division has the worst growth prospects. Based on interviews I have seen of him, I have a lot of respect for the man as he really seems focused on enhancing shareholder value. By splitting up he is robbing himself of power but for the benefit, hopefully, of shareholders.

I am not going to go out and recommend this stock or do a real analysis on it due to lack of time. I will tell you that a number of value investors including Chris Davis and Warren Buffet (albeit a relatively small percentage of his portfolio) hold the stock. I have also seen many arguments for why the sum of the parts will equal the higher $30's or low $40's (stock currently trades at $32.50) and they seem plausible. A decent article on the breakup can be found here.

From the article:

Bates sees the health unit eventually trading for $15 to $17 a share, or 17 to 19 times the earnings he projects.
..
Bates figures the electronics business is worth $12 to $14 a share, on a P/E of 16.5 to 19.
..
In all, the unit containing fire, security and other businesses should trade for $11 to $14 a share, Bates says, with a P/E of 15 to 17.

I own a position in Tyco from before the spinoff was even announced and before I started this blog but I never bothered to put it on my stock list. Personally, despite what the value guys are saying, I would be hesitant to throw new money at it. I just can't get over that it was selling for $25 this summer.

Spinoff Tracker Index

2007-02-05T07:49:00.000-08:00

Clear indexes has built an index of a variety of spinoff companies, here. I am not sure that you can actually invest in the index but for those looking for a list of spinoffs this would be a good starting point. Unfortunately, the spinoffs don't show up on the list until after they are spun out and even then, the index is only updated semi-annually.

A description of the indexes methodology is as follows:

Potential Index constituents include all equities trading on major U.S. exchanges of companies that have been spun-off within the past two years.
The Spin-Off Index comprises the 40 highest-ranking stocks chosen from the universe of spun-off companies.
Each company is ranked using a 100% quantitative rules-based methodology that includes composite scoring of several growth-oriented, multi-factor filters, and is sorted from highest to lowest.
The 40 highest-ranking stocks are chosen and given a modified market cap weighting with a maximum weight of 5%.
The constituent selection process and portfolio rebalance is repeated semi-annually.

I have a couple of problems with the index beyond it's use as a reference. In general, I have a hard time believing that any semi-automated system can do well over time. Also, having an analytical background, I am very skeptical of past performance studies, in this indexes case the performance is tracked back 5 years. Anything less than 20 or 30 years is meaningless in my opinion, and even then, who's to say the next 20 to 30 years will be the same as the past. If you do insist on automatic selection then you better have a broad sweep of companies (500+) to provide for diversity. Also, with the vast growth in hedge funds any well-documented and successful strategy, e.g. picking spunoff companies, tends to get exploited and the gains reduced. Not to say that spinoffs aren't attractive, in some cases they certainly are, just that they are not what they once were. That is why I don't actually buy the majority of spinoffs I see, I still try to apply qualitative and quantitative analysis, and pick the most promising ones.

Anyways, that's just my opinionated ramblings and maybe it's just my ego talking. Like I said, the list is certainly worth monitoring if you're interested in special situations.

Nikko Cordial (NIKOY.PK) - Possible Delisting

2007-02-03T07:34:00.000-08:00

Controlled Greed has some coverage of a possible delisting in a Japanese ADR, Nikko Cordial. I highly recommend you read the comments as that is where the real goodies are.

Verizon Communications Inc. (VZ) - Spinoff

2007-02-02T16:00:00.000-08:00

Telecommunications giant Verizon Communications Inc. (VZ) announced it will be spinning off it's consumer telephone business in Maine, New Hampshire and Vermont. The divisions will be sold/traded to an existing company Fairpoint Communications, Inc. (FRP). Details on the transaction are as follows:

The Verizon operations being sold would first be transferred to a newly created unit that would issue $1.7 billion worth of new debt before being sold to FairPoint.

Of the $2.72 billion being paid by FairPoint in the deal, Verizon shareholders would receive about $1.02 billion in FairPoint stock. Verizon would receive $1.7 billion, consisting of both cash and an undisclosed portion of the debt securities issued before the spinoff. Verizon would not own any shares in FairPoint after the transaction is completed.

...

The deal with FairPoint is expected to be completed within the next year.

FRP currently has a market cap of $720 Million so this is an absolutely massive transaction for them and for that reason alone, worth monitoring.

Verizon spun-off it's yellow page business to form Idearc (IAR) a few months ago.

These are the type of strategic moves I like to see in a company but I still dislike the underlying businesses. High debt load, commodity characteristics and slow growth, I just can't find anything too attractive here.

Altria Group (MO) - A few more things

2007-02-01T16:10:00.000-08:00

I've been thinking fairly obsessively about the Altria Group (MO) spinoff of Kraft (KFT). This isn't a fully fleshed out post but I wanted to pass on a few things..

1) Excluding Kraft, MO's earnings last fiscal year (ended just a few days ago) and the year to come are as follows:

... Excluding Kraft's contribution in 2006, which came in 2 cents per share higher than we had projected, and excluding certain items, Altria's adjusted EPS last year was $4.05. This year, the company expects earnings from continuing operations, including charges of 8 cents per share, to reach $4.15-4.20 per share, good for about 5% earnings growth. This figure, which is based on constant currency rates, isn't comparable to analyst EPS estimates of $5.62.

Consider that .7 shares of KFT will be distributed for each share of MO. At $34 a pop, this indicates $24 of MO's value is for KFT. Excluding that amount, gives up a per share value of post-KFT MO at $63.50. If earnings come in as expected, you are looking at a P/E of ~15.3. Not bad for a non-cyclical stock with incredible margins.

2) Kraft may receive better debt ratings from Fitch Rating and S&P by removing it's linkage to MO.

Fitch said the removal of Kraft from Altria's umbrella will allow the service to rate the food maker based on its own merits and will not be dragged down by the litigation risk carried by Altria

3) This may be just the start of the special situations at MO.

Next, analysts expect the New York-based company could split its domestic and international tobacco divisions later this year.

Norton believes that could be followed by "monster stock buybacks" worth as much as $40 billion.

"The important thing to bear in mind in our view is that this is really just the beginning of a process from Altria to increase shareholder value," Norton said.

4) Found a reference here to the cost impact to Kraft of lost synergies:

These costs include taxes and shared services, as Altria has been providing some of Kraft's information-technology needs," the analyst wrote. "We guess these incremental costs, which are likely to continue for years, may total 10 cents to 15 cents a share."

So is it a buy? Which one is a buy? Are these good candidates for options? These are all things I am debating right now, all opinions are welcome.

I wrote another post about the spinoff a few days ago here.

Altria Group (MO) to Spinoff Kraft (KFT)

2007-01-31T15:52:00.000-08:00

Altria Group has finally announced that they will be spinning off the remaining chunk of their Kraft ownership (88.9% of outstanding shares). Nothing new here as they have been talking about it for years. The spinoff is to happen on March 30.

From the article:

We continue to view the spinoff of Kraft as a wonderful thing for Altria shareholders but an extremely disruptive event for Kraft shareholders," wrote D.A. Davidson & Co. analyst Timothy Ramey in a research note.

The analyst said that the more than $50 billion of Kraft equity will need to find a home all at once, likely causing an extended oversupply of the company's shares.

"It is such a huge amount of equity, equal to about 40% of all the market capitalization of slow-growth large-capitalization food companies currently owned by institutions and investors," Ramey added.

..

The spinoff also frees up Kraft to pare its portfolio more aggressively. The company has been shedding businesses to focus on core categories such as biscuits, cheese, coffee and refrigerated beverages.

S&P now has a strong buy rating on MO and strong sell on KFT.

If I was a gambling man I would probably buy June MO calls and June KFT puts but such short-term speculation just is not my style.

If anything, I will just sit and watch this one out. If KFT really does get nailed post-spinoff then at some point I would definitely buy. However, at current prices the company seems fairly valued. Kraft is low-growth, already has a ton of debt and expenses are going to rise post-spinoff due to fewer shared costs. The only thing I'll give the company is that margins aren't bad. I am actually fairly sceptical that you will see the much prophesized selling in Kraft shares, given the massive liquidity in the system right now.

Anyways, March 30 is the day, keep an eye on it.

UPS (UPS) - Established a Long Term Holding

2007-01-30T16:51:00.000-08:00

I continued purchasing for my taxable account today, picking up UPS (UPS) at $71.41 after less than impressive guidance knocked the stock back a touch. The company is only predicting earnings growth of 6-10% in fiscal 07 and this has some investors worried. Personally, I think management is just being cautious, and I think that's a good trait. I am buying this stock for the future so I could really care less what happens in 07 or 08 or even 09. So long as the company can perform in the long-run. I will also just mention that if UPS has a bad year, a LOT of other companies are going to have bad years.

My main rationale for buying the stock is similar to Western Union. I think the company has a dominant market position with margins to back it up. The sheer number of drop-off points, the massive logistics system and the brand name are not easily duplicated. On top of that management is buying back stock (~2.75% of outstanding shares last year), paying a dividend of ~2.1%, and staying focused on their core business. There is also a tradition at the company of grooming management from within, in my opinion that tends to accumulate value to the firm.

There is still plently of room for growth in the international market, consider that international revenue was $2.5 billion compared to $8 billion in the US alone. The company is also segwaying into providing supply chain solutions. The results have been less than spectacular to date but I have faith that management will turn it around or else cut it loose (spinoff?).

To summarize, I am buying quality with UPS and for a reasonable price. Not a special situation, not an amazing deal, but it has the potential to deliver. Barring economic ruin, with stock buybacks, dividends, earnings growth and an increase to the PE ratio, I have the potential to double my money over the next 4 to 6 years with reasonable downside. Even better, I can probably hold it for a lot longer than that if I continue to like what I'm seeing. For a taxable account, I think this is a good deal.

NCR (NCR) to Spinoff Data Warehousing unit

2007-01-29T17:13:00.000-08:00

NCR will be spinning it's data warehouse division, Terradata.

NCR, which manufactures a range of products including ATM machines and bar code scanners, said the move should be tax-free and will help each company better focus on their own individual customer base and business strategies.
...
In 2005, Teradata generated $1.5 billion in revenue and $309 million in operating income, NCR said.
...
..is expected to be completed in 6 to 9 months..

Another article adds..

NCR's total revenue fell 2% to $4.55 billion in 2005.

Check out NCR on yahoo here.

The SEC filing on the spinoff is here.

From the SEC filing:

Following the spin off, Bill Nuti will continue to serve as president and CEO of NCR, and Mike Koehler, currently senior vice president of the Teradata Division, will serve as president and CEO of Teradata.

Wikipedia has a lot on teradata here.

A few things from Wikipedia:

The largest and most prominent customer of this DBMS is Wal-Mart, which runs its central inventory and other financial systems on Teradata. Wal-Mart's Teradata Data Warehouse is generally regarded by the DBS industry as being the largest data warehouse in the world

The company has quite a bit of coverage on it's internal website here.

Hedge Hogging

2007-01-29T16:45:00.000-08:00

I just finished reading Hedge Hogging by Barton Biggs the other day. The book was excellent, well worth the read. It is quite succinct but manages to cover numerous investment topics and I think most investors would take something from it.

While it is primarily focused around hedge funds, the book is also an excellent overview of the investment landscape. Value, growth, momentum, charting, gold, macro-economics, the book pretty much covers all the major areas. It is put together using a number of case studies which really drew me in. Not working in the investment field I am always curious how the pro's approach things. What I found from reading this book is that they are not as organized or all knowing as I sometimes give them credit for. In fact, they are very much pushed and pulled by their investors to the point that it may impede their long-term performance.

If anything this book strengthened my view that in spite of the vast number of hedge funds, mutual funds and other investment vehicles out there, there are still inefficiencies in the market. That is the fundamental reason why I invest my money in individual stocks instead of just dumping dumping it into index funds.

I will borrow just one quote from the book, which I found to be particularly insightful:

Tim is convinced that hedge funds, because of client pressure, have become obsessed with avoiding monthly declines in net asset value (drawdowns). As a result they employ stop-loss limits and all kinds of risk-control mechanisms that mechanically make investment decisions for them. Most of these decisions are bad. They never fight the tape and brag about how market neutral they are. As a result, they become short-term, momentum-oriented traders. He argues that this creates an opportunity for an investor who uses leverage, is willing to accept volatility, and who is long term in his thinking. "Accept volatility and concentration", he says. "Diversification is an enemy of performance."