Thursday, September 29, 2005

Whitehall Jewellers

Now that Finlay is out of the way, I thought I'd take a look at one of its comparables called Whitehall Jewellers. Over the past couple of weeks, this stock has tanked from a high of 6 to 1.38 today--and I got to wondering, what the heck made this happen?

There has been nothing but bad news for this company over the past year, and starting September 8th, everything went down down down. Prior to the huge drop, Whitehall Jewellers has had a two-year history of corporate fraud and lawsuits regarding the transfer of money by the CFO. They paid approximately $20 million in legal and professional fees which pretty much killed their cash balances. And when the original executives left office, they put in place a new CEO nammed Raff. A little bit before September 8th, Whitehall Jewellers had asked the AMEX to suspend trading on their stock prior to the announcement of what they considered to be "significant news". Lo and behold, after a couple of days of investor suspense, a press release comes out stating the resignation of the newly appointed CEO who hasn't even started her term. This sent the stock tanking from around 4 to 1. And now, default notices from creditors are coming in as Whitehall straps itself for a rough ride. It has no cash reserves and looks to be on the brink of bankruptcy.

Why is this opportunity interesting? Just today, the stock went from 1 to 1.38 a share--and at first glance this may seem just like market madness. But could it be that the markets overreacted to all this news?

Looking at the balance sheet, one will notice a book value of approximately $80m on Yahoo! Finance... and the stock's total market cap is currently 19.88m. Whoa whoa. You can buy this company for 20 cents on the dollar? At least, when you think Jewelry store, you automatically think inventories filled with gold, riches and diamonds... Of course the markets have overreacted! How could they not have seen that even if the company did go bankrupt, it would still liquidate at a higher value than what investors are willing to pay for? Perhaps that the big realization of today...

Taking a much closer look at the balance sheets, one will notice that it's tangible book value actually derives from some things which aren't so "tangible" after all. There are 3m in deferred tax and deferred costs, and some other things that decreased the value of tangible equity. The biggest whammy was perhaps the 52m worth of "Property and Equipment". Property and equipment sounds misleading here, because the only "property" this company has is furniture and fixtures, and some leasehold improvements they probably won't be able to sell off unless it's at a significant discount, along with capitalized operating lease expense. Ha. Equipment is more like software development costs they've capitalized... in other words, property and equipment could probably only be realized at most 5 - 10% of its balance sheet value on liquidation.

This still puts us at a 26m real tangible book value however, and the market is currently pricing the company at 18.99m. Buy! You say... that's still a hefty upside! Ahh... that is where you must reconsider my investor friend--you see, this company is far from complete in paying off its legal expenses and recruiting expenses for a new executive going forward. It will probably end up losing money again if they don't go bankrupt. In fact, it's conservative to estimate that they will lose 10m again this year. So pricing in that expectation, in a year, the book will be worth 16m.

2m downside v. a 8m upside is a great bet, you say? Well, let me go a step further that default on credit doesn't necessarily mean "liquidation" (chapter 7). It could also mean "reorganization & restructuring" (chapter 11), which would put the debtors in charge of the company going forward--all debt converts into equity, with liabilities forgiven. Now, you might think it's still the same 26m left to equity shareholders going forward even with that happening, because now you have the decreased debt to make up for the dilution in equity. But ahh, think back again to the 10m they will be expected to lose on legal expenses for a longer time to come, or more generally, think of future losses this company will suffer without a proper management and cost structure. If that continues year on year, eventually, the original equity will be pushed near zero, and that, my friends, is the major downside risk.

No buy! (but will buy at $1.00 per share). That's our thesis and we're sticking to it :D

Wednesday, September 28, 2005

Sell Now, Buy Later

I never thought I'd turn into a trader... but I feel like I have to do something like this with Finlay. Press releases keep coming out that negatively affects the company--even though many of the things mentioned are already exhibited in their recent financial statements. 184 store closings as a result of the Federated and May mergers... Not until Mother's Day, and when they start they will go on until October 6th 2006.

The markets punished the stock pretty hardcore today, giving it a downside of 15%... putting our total losses in the initiative for this stock to about 30%ish--about a 3 and a half % downside for the portfolio as a whole can be attributable to FNLY.

I won't lie, this sucks. The most important lesson I've learned with this stock is that I really shouldn't think I'm smarter than the market. Yeah, sure, it makes no sense for a jewlery company with most of its tangible value in jewlery to be trading at below book value, but the market is also half hype and half numbers. It knows when it doesn't like something, and 184 store closings--although it doesn't affect the balance sheet at all (for all costs related to closing would be on the 'host' stores)--is still horrible news.

With the negative catalyst in the Sept. quarter--the losses of approximately 3m, I don't expect the market to take things more lightly, and the stock will probably get punished even more.

I will definitely look at the stock again Nov ~ Dec, when the price is at rock bottom. With Christmas earnings in sight, I will make a decision to buy or sell around that time instead. The downside risk is simply too much for me to take as of now.


Damn you Finlay! Damn you!!!!

Tuesday, September 27, 2005

Value... or is it?

I take back what I said earlier about there being a lack of "value" stocks on the market... in fact, there are a bunch of value stocks out there if by our definition value means cheap cash-flows. Just recently, for example I've found as many as 5 or 6 companies that fits the cheap cash-flows criteria. A cursory glance at their financial statments will reveal that they are trading at around 5x free cash (I have to confess, a stock I currently hold, Yellow Roadway, is an example of this 5x past and current financials)

Now, I didn't complain about there being a lack of value because I am having trouble finding companies that could potentially be value companies, I'm complaining because all the potentials turn out to be duds. It's not only cheap cash-flows that is important to the upside of a company... what's even more important is the company's ability to sustain those cash-flows for the long-run. It's hard to find solid, sustainable companies with certainty and clear business objectives going forward. See, there has too be a reason why the business is trading at the multiple it's trading at, and if a company is trading at 5x free cash flow, the main reason for buying into the company is that it should be able to generate at least the current cash flows for more than 5 years, and some of the rinky dink companies around that has the facade of being cheap at 5x probably will never get the chance to make 5x the current investment.




What the dang is with all this blogspot spam? I must have gotten comments from 4 bots by now.

Sunday, September 25, 2005

Well, I found a rather interesting company this weekend... with a pretty solid positive and negative thesis. I'd like to expound on it right now, pardon my french :D is an internet yellow-pages service provider for local businesses in the U.S. They provide listing on the internet for free...

to be continued...


Actually, screw YPNT... they have some horrible short term costs that will probably screw their next quarter. I'd wait until after that to see what happens, and THEN I will buy :D

Saturday, September 24, 2005

The Value Manager's Tragedy

Sometimes, catalysts won't kick in for your value stock until the price tumbles a good dozen percentage points or two. And that my friends, is what I'd like to call, the Value Manager's Tragedy.

Friday, September 23, 2005

The Certainty Game

So this week I think I learned a valuable lesson on certainty, and it can be cited quite well with two investments that I've recently made in the initiative portfolio. One gained tremendously and the other lost tremendously... in both cases I've known the catalysts with a reasonable amount of certainty. But I diverted in the way in which I handled those certainties. Here were the two certainties I knew analyzed in 20/20 hindsight:

Certainty #1: Finlay Enterprises was going to write down $77m of goodwill and intangibles from their balance sheets, reducing their stockholder's equity down to $93m from $170m. Their accounts payable seems to outpace their accounts recievable, and from the outside this company looks like they are going to go bankrupt soon.

Certainty #2: Omni Energy Services has extensive operations in the environmental clean-up sector down in Lousiana, and the markets priced it as if Katrina would not affect profitability at all. While each and every one of its peers gained tremendously in the market, Omni Energy stayed put.


I handled certainty #1 with a bit of self-doubt. Goodwill and intangible writedowns are "non-cash" expenses, and would not really affect the business going forward in terms of its real operations and tangible profits. Shouldn't the markets have known that already? Before the write-down, the markets priced the security at 120m, and after the write down, it got pushed down to 90m.

The spread between before and after seemed like "priced in growth" to me, after all, the company makes about 25m a Christmas season on top of their losses in the previous quarters. Alas, when the write down made it onto the Yahoo! Financial sheets, the markets reacted strongly by pushing this stock down--way down. Now it trades at tangible book value with no priced in growth. Maybe some of you would be interested in investing right now? Because once February rolls around--the markets are going to make this company jump again! Unless, of course, their working capital and liquidity cannot sustain the interest payments that this company has to make... in which case, "Bankrupt!" There's a price to pay for this risk.

I bought this company at 12.01, and now its down into the high $9.80s... a pretty dramatic loss of approximately 20%. I truly didn't expect the markets to react so strongly to the goodwill. Maybe it's a combination of that, high oil prices, and Katrina, and the possibility of Rita decreasing consumer disposable income. Will consumers be buying much Jewelry for their loved ones this x-mas season?

We had 8% position in the portfolio, and with the loss, it's down to above 6%


Certainty #2 took the cake. Press releases came out Wednesday announcing the company's intention to acquire Preheat, a company with extensive clean-up equipment and personnel. The reason cited by management was " cope with increasing demand for Omni's environmental services". Can we say Katrina? The markets jumped at this stock, and needless to say, we made a hefty sum.

We had 3% position in the portfolio at the time, and now it's up to a little above 4%


The point I'm trying to make is that certainty can come in various forms. But the best kind of certainty is the positive kind with very little risk involved. With Finlay, it was a negative certainty that I tried hard to make positive with notions like "the markets are smart enough to figure out the expense is non-cash and intangible", but alas... I was punished for that! With Omni, it was a positive certainty, and I'll let you in on a little secret. I didn't have that big of a position in the portfolio because I wasn't too confident about the market recognizing that itty bitty environmental sector worth about 15m. Well... look how that turned out.

I made a mistake in evaluating risk in the two opportunities. The first certainty is riskier, and I dubbed it less risky. The second certainty is less risky but I dubbed it riskier.

Well, but like they say, Hindsight is always 20/20. But maybe we can all learn a little from this story :)

Tuesday, September 20, 2005

Terminal Value of Free Cash Flow

I've got to thinking a little bit about financial theory today while talking to my buddy Krish at Wendy's. As I was gobbling down my Jr. Bacon Cheeseburger, Krish brought up an interesting point about the discount rates used in the Terminal Value of an investment: Why is it that the factors affecting the discount rate (cost of capital, cost of debt, beta, etc.) discounted at a lower risk rate even though it is for a longer period of time--thus more possibility for risk and volatility? In other words, shouldn't "forever" be more risky than 5-7 years in the growth assumptions?

I was sitting on the toilet just now--ohh the discoveries we men make while thinking on the toilet, and I got to thinking about that. At the time of the conversation, I couldn't think up anything more intelligible than "it's probably some mystical financial theory that we simply have to adhere to"... but the more I think about it, the more I think I have an answer.

Traditional financial theory defines risk as the probability of short-term loss and volatility swings in the stock price, where-as we "value" managers like to think of risk as the "permenant loss of capital" rather than silly market reactions. The inherent difference between the traditional model and the value model is something that financial modeling has yet to capture. What we are assuming in a traditional discounted cash flow model when looking at the earnings of a firm is that it is going to inherently become more stable as the business grows to a point where it can only grow no more than GDP, at which point its margins stabilize and investors are less subject to "surprises" that would create uncertainty. If its anything the markets hate more--it's uncertainty. Yes, even positive uncertainty where companies earn more than they are supposed to... although that sort of hate primarily comes out as a result of companies not being able to keep up the wonderful "surprise" for many more quarters and fiscal years to come.

Of course, the factor in traditional finance theory that measures this sort of love-hate relationship in stock price volatility is the beta. The beta measures the ups and downs of a stock compared to a basket of other investments like it (most of the time, the beta of a stock is measured by comparing the risk of the security in question with the securities like it in the same industry). When an investment grows faster or slower than that basket, then the beta gets above or below 1, respectively. Now, any student of finance can tell you that a major factor that lowers the discount rate is the beta. In other words, a stock that is less volatile is also less risky. When the performance of a company gets projected into perpetuity, it is assumed that the stock becomes more and more like the larger whole, and thus its beta decreases while reducing the terminal cost of equity (and then WACC).

So in a nutshell, in traditional finance theory, risk is synonymous to volatility. A stock becomes stable as expectations of market expectations become normalized on a forward-going basis (which makes no sense I think--something I'll have to write on later). In exchange for less volatility, a firm is given less growth and shrunken margins to offset the gain in net present value as a result of lower risk.

Now... we value managers don't exactly look at the markets the same way as DCF enthusiasts. We are much too paranoid to feel comfortable projecting earnings on a perpetual basis. While I personally believe that the Present Value of Terminal Free Cash Flow might have some merit in extremely large, indestructible businesses (perhaps... the world economy itself), it certainly doesn't do much in light of reality. Reality is much more cruel, but cruel in a good way. If DCFs worked all the time, then there would be no value left anywhere!

The main difference between value and traditional finance theory is the way we view risk. While traditional finance theory is generally optimistic about growth opportunities and eternal survival of the firm, we value people tend to look at the downside much more. Our risk is not "volatility", our risk is "the permanent loss of capital". Value investing is a combination of relative valuation and fundamental valuation in that we hedge against our risk and expect most of our upside from comparables and tangible book value, not promises of future cash.


That's my story at least. Have you ever gotten a feeling that you teach yourself by talking or writing to yourself? Sometimes you find things you didn't even know you had... Well, I'll leave that for the metaphysicians to figure out :D

Monday, September 19, 2005

Yellow Roadway

I've been looking at this company the whole day: Yellow Roadway Corp. (Ticker: YELL), and found some very lucrative acquisitions and joint-ventures that this company is pursuing with its money. This is a company that makes its living transporting goods and arranging logistical supply lines for companies. What I love about this company, for the first time in a long time, may not be the existing fundamentals, but the promise of growth.


This is a company that is now dabbling into the Chinese supply-logistics market through a joint-venture with the second largest air-freight and transportation business in the Shanghai area. Not to mention it's recent acquisition of a business very much like its own... it hasn't even finished creating synergies yet there and we can expect to see some very nice productivity and margin gains once the overhead costs of corporate administration is cut.

What I love about the transportation business is that the more it acquires, the larger it's customer networks get. And the larger it's customer networks get, the more new customers can be acquired through buyer/supplier lines. This is a business that more or less grows organically, and with enough lock-in opportunities with database and software, they have pretty good retention strategies going forward.


The markets hate it when a company revises its own earnings estimates (especially when it is downwards) and that's exactly what happend with this particular stock. This company tanked 11% as soon as announcements were made that the EPS estimates would be adjusted from 1.60 to 1.40 for the 3rd quarter due to the effects of Hurricane Katrina on business, and due to the operational deficiencies and the longer-than-expected synergistic adjustments of Roadway Express.

Looking at the downward momentum, one gets a little scared whether or not the downward trend would continue into the future. I've decided to purchase this stock because of the very recent, very specific announcement of stock buy-backs stating specifically that the equity for this company is "significantly undervalued".

Just looking at the comparables also, this company seems to have a pretty good downside cushion, and since earnings will not be expected to go into the negative, I am not too worried about things "blowing up" as comparables will always be a nice cushion to land on when peer companies are trading for around 10x earnings.


I'm willing to hold this stock until earnings come out on Nov 9. Thats close to a month and a half from now... we'll just have to see what happens!

*crosses fingers

Saturday, September 17, 2005


Is it me? Or is "Value" investments getting harder and harder to find these days?
It used to be just going on hoovers, doing a couple of screens, and you'd be able to find a few ideas to research on, but now it's taking so much time just to find one or two!

The typical S&P 500 company is now trading at about 15 - 20x earnings--can we say overvalued? Companies trading for cheap these days actually have a good reason to be cheap, unless the investor can somehow hedge against the risks of downside of course. We are forced to become more creative and more sensical in our valuations, and not simply be able to project numbers on a forward basis. It's really tempting to just settle for the 10x cash and hope it will go to 15x soon enough... but we are sticking to our dicipline!

And nevertheless, since the IAG portfolios will be running "value" strategies this year, we are confident that in the areas where institutional investors and wall street at large do not see, we will be able to find good investments. Though nobody says that this is an easy process :(

First Meeting

Thank you everyone for coming to the first IAG meeting this year. I really enjoyed talking to many of you after the club. You guys asked many good questions and I really hope that I had answered them all to your satisfaction.

I'm very glad to know that many of the things Krish and I mentioned were not too complicated to you. As you know, IAG is a club that stresses the importance of investment competence and knowledge when it comes to making bets on the market. But again, if there is ever anything you guys don't understand, please feel free to ask any questions--we will answer them to the best of our abilities.

I hope that when we went over the companies we currently have in our portfolio, we were not overly brief in our speeches. If any of you are interested in finding about them further, please visit the IAG message forum. Krish and I have our trades posted and our reasons behind the trades. We generally don't hand out our excel valuations to the public, but if any of you want to look at valuations in depth, we would be more than happy to send them to you in .pdf format.


Since Krish started his book recommendations, I figure I should try and do the same. Reading books greatly increases the breadth of your knowledge, and I strongly suggest the following to get ahead in your investment careers:

- Bull's Eye Investing - John Mauldin
- The Alchemy of Finance - George Soros
- When Genius Failed, Rise and Fall of Long Term Capital Management - Roger Lowenstein
- You Can Be A Stock Market Genius - Joel Greenblat
- Security Analysis - Ben Graham & David Dodd
- Investment Valuation - Aswarth Damodaran (Free on his website :))
- Fooled by Randomness - Nicholas Nassir (sp) Taleb
- The Bull Hunter - Dan Denning

Also, some really great investment newsletters you should subscribe to:

The Daily Pfennig
John Mauldin's Weekly Newsletter
The Daily Reckoning
The Rude Awakening


By the way, I'm still trying to find someone fluent in Korean to help me read KEP news announcements, so if you are interested, please leave me a comment. The whole thing probably won't take more than 10 min (we will go on bloomberg, and then look at the Korean language articles together) :D

Tuesday, September 13, 2005

First post

Hello, I will be posting my investment musings here. Feel free to leave any feedback and comments you have :)