Tag Archives: Valuation

Limco-Piedmont to Delist

limco-piedmontLimco-Piedmont (LIMC), which we previously profiled on May 1st, has filed to delist.  The shareholder meeting was scheduled for 10 am today (July 2nd), and shareholders were to vote on a plan of merger with its majority owner TAT Technologies (which holds over 60% of outstanding shares).  TAT has offered 1/2 share of its stock for each share of LIMC.

On the day we profiled Limco, its stock closed at $2.54 per share.  Today, TAT trades between $7.6 and $8 per share.  During that span, the S&P 500 moved from 878 to 919 (yesterday’s close).

Disclosure: I, or persons whose accounts I manage, own shares of Limco-Piedmont at the time of this writing.

Valuing Limco-Piedmont

lpTHESIS: Limco-Piedmont Inc. (LIMC), trading at less than 50% of book value and about 55% of net tangible assets, offers both a compelling merger arbitrage opportunity and the potential for long-term gains. However, this opportunity is not viable for larger funds, as Limco has a market capitalization of $33.5 million (as of 5/1/09), and in the last three months, has averaged about 26,000 shares traded per day.

BUSINESS: Limco has two business segments—a MRO (“Maintenance, Repair, and Operations”) service for the aerospace industry, as well as a parts supply service. Their FAA certified repair stations provide aircraft component MRO services for airlines, air cargo carriers, maintenance service centers and the military. In conjunction with their MRO services, they are also an OEM of heat transfer equipment for airplane manufacturers. The parts services division offers inventory management and parts services for approximately 600 commercial, regional and charter airlines and business aircraft owners.

Both segments appear to have relatively similar margins, though the parts customers are less ‘sticky’. With credit tight and likely tightening, one tailwind for Limco’s businesses in the next few years will be those carriers who lengthen their fleets’ useable life, electing to maintain and repair older craft rather than replace them with new.

HISTORY: Limco had its IPO on July 18, 2007. Previously it had been a wholly-owned subsidiary of TAT Technologies (TATTF). The IPO raised about $46.2 million, placing 4.2 million shares at $11 per share. TAT retained a majority stake in Limco, which currently has 13.2 million shares outstanding. As of December 31, 2008, TAT held 61.7% of Limco’s outstanding shares.

BALANCE SHEET: Limco has a fortress balance sheet. As of 12/31/08, they had $21.3 million in cash and equivalents, and short-term investments of $11.3 million, consisting primarily of government and corporate bonds and auction rate tax exempt securities. As you would expect, the auction rate securities are currently illiquid, but only amount to $2.25 million of the short-term investments.

Inventories stood at $19 million at 12/31/08, accounts receivable at $11.8 million, and other accts receivable and prepaid expenses at $1.3 million. Total current assets then were $64.8 million, or $4.91 per share. PPE less depreciation was $6.0 million at year end, for $5.36 total in tangible assets per share. Intangible assets and goodwill totaled $6.2 million, which brings total assets to $76.9 million, or $5.83 per share.

Total current liabilities were $9.483 million, and the only long-term liabilities were deferred taxes of $0.8 million. Total liabilities then were $10.3 million, or 78 cents per share.

INCOME STATEMENT: Limco earned $2.7 million in 2008, or 21 cents per share vs. $5.2 million in 2007, or 47 cents per share. A large portion of 2008’s decline came from two one-time items: 1) $1.4 million in scrap expense, related to a “new program start-up in the OEM division [that] we believe should not be recurring,” and 2) an increase in general and administrative expenses “primarily attributable to approximately $837,000 in one-time SOX and public company costs.” (10-K)

MERGER ARBITRAGE: On April 3, Limco announced that it had entered into a definitive agreement and plan of merger with TAT Technologies for one half share of TAT for each share of Limco. For the week April 13-17, Limco traded between $2.32 and $2.48, and TAT between $5.12 and $5.51. If one were to set the long LIMC/short TATTF trade well, that spread has ranged between 5-20% since the announcement.

However, it is my belief that there is a better than 50% chance that TATTF will have to come back with a higher offer to close this deal, as at least a handful of litigious types have been trying to organize shareholders to block the “unfair price” (e.g., Levi & Korsinsky, LLP). So what’s a fair price?

VALUATION: At the highest end of the range, one could argue for a buyout at the original IPO price of $11 per share. Book value and cash have increased since the IPO, and Limco has added some valuable capital expenditures to generate future earnings power. In effect, $11 per share could represent paying book value of $5.05 per share, plus a 11x multiple of $0.55 per share annual earnings power. Though $0.55 exceeds 2007’s numbers, TAT could realize such earnings fairly easily through the additional cost savings that Limco would gain if it no longer publically reported and filed under Sarbox. For TATTF and other potential buyers, the regulatory cost savings for a company this small will significantly impact its future earnings power.

At the low end of a valuation range, one could value LIMC’s assets in liquidation. A conservative liquidation analysis would value cash and short-term investments at 100%, the auction rate securities at 75%, accts receivable at 75%, inventory at 50%, PPE at 20%, and liabilities at 100%. This would yield a liquidation value of $32.44 million ($30.35 million+$1.69 million+$9.5 million+$1.2 million-$10.3 million), or $2.46 per share.

However, in my lights, the liquidation value of LIMC understates its intrinsic value, given its demonstrated earnings power. Thus, a fair price for Limco as a going concern would likely include paying for their net tangible assets, plus an additional multiple for the earnings power. For a business with high capex costs, the same approach may overstate its value (see, e.g., Buffett’s reflections on overpaying for Berkshire Hathaway though it traded below its net tangible assets). Yet, Limco’s capex in 2007 was $2.9 million, and $1.7 million in 2008; both of which included some one-time items. Maintenance capex for Limco is likely close to its $1 million depreciation expense over the last three years.

With net tangible assets of $60.5 million, or $4.58 per share, and a 5x multiple of what I estimate to be their average annual free cash flow of $4 million, you get a value of $80.5 million, or $6.10 per share.

Of these three values, the last I find most reasonable, and representative of what a knowledgeable buyer should be willing to pay for the whole business.

Were shareholders able to get a better price, the upside could be substantial. Even an offer of $4 per share (still below net tangible assets) would represent more than 50% upside at these prices. Yet, even without a better offer, the long/short arbitrage should return 5-20%. In the event that the merger does not close, Limco at these levels offers a significant margin of safety to my estimate of its private party value.

Disclosure: I, or persons whose accounts I manage, own shares of Limco-Piedmont at the time of this writing.

Moody’s Intrinsic Value

moodys-logo2008 was a tough year for Moody’s Corporation, with free cash flow (FCF) levels falling to 2003 levels, or $450 million. In our previous analysis, we argued that Moody’s economic moat has shrunk over the last couple of years, as its credit ratings for structured finance products proved unreliable for predicting distress and default risk. So far though, Moody’s credit ratings for municipal and corporate debt have been reliable. The question for today—what price would Moody’s Corporation command from a private buyer in light of recent events?

In the past, we have introduced Seth Klarman’s three methods for valuing a business—by determining its liquidation value, the net present value (NPV) of its future cash flows, or its value relative to similar businesses trading in the public markets. Since Moody’s has a negative book value and has no comparable standalone competitors in the public markets (Standard & Poors is embedded within The McGraw Hill Companies), the NPV approach here is appropriate. And with the help of Morningstar’s FCF data, a NPV analysis is not a difficult exercise.

Since 2001, Moody’s has grown its FCF from $291.5 million to $450 million (FY 2008). As many know, in order to value future cash flows, an investor must make a reasonable estimate what they will be. In Moody’s case, estimates could vary widely, as its FCF in 2007 was $802 million. If we use past growth rates of FCF to estimate Moody’s future, we will get very different growth rates using the FCF data from 2002-2007 vs. those from 2001-2008. The former period shows a FCF growth of 20.4%, and the latter 6.4%.

For today’s analysis, I will use the latter—a 6.4% FCF growth rate—as it likely better approximates Moody’s business prospects over the next decade. Following upon a period of robust growth in its structured products ratings division—a division whose revenue has now fallen by half YOY—it is hard to imagine Wall Street’s structured products returning to their previous levels in the near future, much less to grow at their past rate.

Assuming then that Moody’s will grow its FCF from 2008’s $450 million at 6.4% per year for the next decade, and then assuming that it will continue to grow at 3% for the following decade, Moody’s should throw off $16.3 billion over the next two decades for its owners. If we discount those cash flows at 9% (an estimate of average stock market returns over the long-term), the NPV of those sixteen billions should be $6.578 billion. However, if today’s buyer offered $6.578 billion, he would be assuming a business with nearly a billion dollars in negative book value. Knocking $994 million off the expected purchase price would value Moody’s equity and future cash flows at $5.583 billion. With 235.2 million shares outstanding, the prospective buyer should be willing to pay $23.74 per share for Moody’s.

Of course, at $23.74, the buyer’s assumptions better be correct, because he’s paying fair value for the business and its earnings power. For investors like Warren Buffett, paying fair value typically does not offer a sufficient margin of safety; to warrant investment dollars, Buffett wants to buy dollars for fifty cents. Here a 50% margin of safety would suggest that the investor only purchase Moody’s below $11.87 per share. As of Tuesday’s close (4/7/09), Moody’s traded close to its intrinsic value, at $22.20 per share.

Disclosure: No position

Valuing Target

target-logo-copy1Friday we compared some big box retailers and argued that Target must serve up its wares with some secret sauce, for it has relatively strong margins. However interesting, if we are to assess Target as a business owner, our analysis should quickly move to its assets and earnings power.

First, the assets. At the close of their fiscal year—January 31, 2009, Target had 44.1 billion in total assets versus 10.5 billion in current liabilities and 19.9 billion in non-current liabilities; shareholder equity then stood at 13.7 billion. Yet, some have argued that Target’s balance sheet currently understates the value of two important assets—their remaining stake in their credit card business, and their real estate property. For example, William Ackman, founder and fund manager at Pershing Square Capital Management, has recently been agitating Target’s management to spin off some of its real estate into a REIT-like structure, with the assumption that the two parts valued separately would demand a higher price than the current aggregate. So what are these two important assets worth?

In 2008, Target sold half of its credit card business to JP Morgan for $3.6 billion; today the remaining half may not fetch the same price, but it is unlikely that it would be worth less than $2 billion. Pershing, in its public presentation on Target, values the remaining credit card receivables at $4.4 billion. A strict average would put a price of about $3.3 billion on the credit card business.

As for the real estate, estimates range widely. In Pershing’s public presentation of its REIT plan on Oct. 29, 2008, they highlight that the gross book value of Target’s owned real estate is $25.2 billion, and its replacement value near $39.1 billion. Were the REIT spun off, Pershing estimates that it would carry an equity value of $29 billion within twelve months (see the Nov 19, 2008 follow-up presentation). Again, a strict average of these three estimates would price the real estate at $31.1 billion.

Of course, there still remains the question of Target’s value as an operating retailer. Any valuation estimate would require some sales and earnings assumptions, but if we take their trailing 5 year average EBIT at $4.5 billion and give it a 6x multiple, we could conservatively value Target’s operating business at $27 billion. In sum, these three parts should carry a fair value of $61.4 billion to a private owner. As of Friday’s close (3/27/09), the market valued the entire company at $25.7 billion.

So, what’s the market missing? If Target is currently valued at less than 50% of its intrinsic value, shouldn’t bargain hunters be snapping up shares?

In my lights, the answer is cash flow. Looking at Morningstar’s numbers, one can see that Target’s free cash flow is quite low, given the wealth of assets that they must use to generate that cash. In fact, it has only broken a billion in FCF once, in 2006. For Target, almost all of its cash flow has been poured back into its business, with capital expenditures consuming at least 75% of its cash flow on an annual basis, for at least the last decade. And the crucial question for the shareholder must be, how long will this endure?

At some point, Target’s FCF does not find its most profitable home in future expansion. Hopefully that point is in the future, but it may be already past. Once Target has built enough stores, future stores will cannibalize the elders. And at that point, capital expenditures will need to come down, and the excess cash flow redirected into more productive endeavors. This is the crucial capital allocation test for retailers; can they transition their strategy prudently? Given Target’s current share price, a good number seem to doubt that they can.

Disclosure: No position

KSW in the Bargain Bin

In addition to holding wide moat companies purchased at a discount, a significant portion of our portfolio resides in profitable businesses selling for substantially less than their liquidation value. As we see it, in these situations, we are not only buying the companies’ assets at a discount, but we are getting its future earnings power for free. We primarily concentrate on micro-cap opportunities, where market inefficiencies tend to be greater, as larger market players are not sufficiently compensated (in absolute terms) to address them. This week we added to our holdings of one such opportunity–KSW, Inc., which the market currently values at $13.52 million (as of 3/13/09’s close), even though it currently has cash and marketable securities of over $20 million (by our estimates) and no long-term debt.

To share a little about the business–KSW, Inc., through its wholly-owned subsidiary KSW Mechanical Services, Inc., furnishes and installs heating, ventilating and air conditioning systems and process piping systems for institutional, industrial, commercial, high-rise residential and public works projects in New York City. Also, KSW serves as a mechanical trade manager, performing project management services relating to the mechanical trades.

As of September 30, 2008, KSW’s book value was $19.32 million, with nearly $17.4 million in cash and $1.6 million in marketable securities. Using data points from the recent press release, the fourth quarter 2008 yielded an additional $1 million in net income. And as of Dec. 31, 2008, KSW’s backlog of work was about $62.5 million.

Though management and the Board could do more to return cash to shareholders, KSW currently has a $1 million share buy back, which was announced in December 2008. Additionally, KSW has paid annual dividends in the past, and last spring they returned a cash dividend of 20 cents per share.

So why is KSW so cheap? In our view, it is likely because new construction projects in NYC are being dropped and current projects halted. In December 2008, KSW announced that two of its projects had been put on hold (the 42nd St and 10th Ave Project for $32 million, and the 56 Leonard Street Project for $24 million). Also, this past week, KSW had one of its customers terminate all of its current trade contracts (on which KSW had about $6 million of outstanding work left).

Yet, does a slow NYC construction market justify KSW’s current share price? In our lights, absolutely not. Its current market price not only values its future earnings power at zero, it values its net cash in the bank at less than 70 cents on the dollar. Basically, the current market price assumes that the company will never earn another dime and will burn through six and half million dollars over the next few years. That proposition strikes us as absurd.

Though some may worry that KSW may not have sufficient work to cover its overhead expenses, it is important to keep in mind that all of its field workers are hired for specific work assignments and hence are not salaried. Additionally, a substantial portion of Chairman and CEO Floyd Warkol’s compensation is paid as a “bonus equal to 9.5% of the Company’s adjusted annual operating profits before taxes, which are in excess of [$250,000].” So, a sizeable portion of KSW’s expenses are not fixed, and should adjust accordingly if less work were available.

All told, KSW’s current market price offers the company’s assets at a significant discount and its future earnings power for free. Though we expect that construction work will decline over the next couple of years in NYC, it will not cease entirely. And if it doesn’t, KSW will likely have work to do, and earnings for its owners.

Disclosure: I, or persons whose accounts I manage, own shares of KSW at the time of this writing.

eBay’s 2009 Analyst Day

logoebay_x451Today is eBay’s 2009 Analyst Day, and the meeting will be broadcast on the web starting at 8:00 AM PT. eBay is one of our significant current investments, and we have produced an extended series analyzing eBay’s economic moat and valuation. So we are eager to see what management will have to say for itself; the stock price has certainly been doing its share of speaking for some time now.

In anticipation of the meeting, eBay’s critics and observers have been pounding the web waves over the last week, offering their suggestions and speculating about future asset sales. Among the suggestions include selling the whole company to Microsoft or Google, selling Skype to Cisco, spinning off a portion of Paypal, and transforming the company into eBay 2.0. Trading at near 6x 2008 FCF, it strikes me that the former is most likely.

At any rate, we’ll be watching and eager to evaluate any proposed changes. Foremost in our minds are the strategic options for their cash held overseas, the possibility of creating an “eBay Local” site that concentrates solely on geographic distance (to snipe at Craigslist), and its progress on the current share buyback. Probably the best plan for current investors would be a coordinated debt offering and large stock tender offer. With no long-term debt and strong, cash flow businesses, they are not optimally levered in their current state. With today’s equity price, it seems a no-brainer to replace equity yielding over 15% FCF with debt costing 5-6%.

Disclosure: I, or persons whose accounts I manage, own shares of eBay at the time of this writing.

Valuing the Washington Post

logo_washingtonpostNewspapers these days are a tough business. The publically traded ones have significantly cut their dividends, with Gannett being only the most recent. The less fortunate (read—those highly levered) have entered bankruptcy, to be chopped into pieces sized for the auction block. Nor has the Washington Post Company been immune to the challenges of this recession, having seen a significant decline in advertising revenue in recent quarters (with print ad revenue down 21% at the Post and 22% at Newsweek ).

As most are aware, the print newspaper business is in serial decline. As Warren Buffett has noted, “when they take people to the cemetery, they’re taking newspaper readers, but when people graduate from high school, we’re not gaining newspaper readers.”

The Washington Post Company however is much more than a newspaper business. In fact, in our lights, less than a quarter of its intrinsic value lies in its newspapers and magazines. Contrary to appearances, the Washington Post Company is an education business. And the numbers bear this out. In 2008, 52% of its consolidated revenues derived from its wholly-owned subsidiary Kaplan, which operates in three business segments: for-profit higher education, test preparation services, and corporate training. In addition to Kaplan, WPO’s assets include: Cable ONE, a cable service with nearly 700,000 subscribers across 19 states; its namesake newspaper and affiliated publications, which include their website and related investments (e.g., Slate.com, The Root, The Big Money); a 16.5% stake in online classified ad provider Classified Ventures LLC; Newsweek and its thirty affiliated publications; The Daily Herald, which publishes The Herald in Everett, WA as well as other affiliated publications; six VHF television stations located in Houston, Detroit, Miami, Orlando, San Antonio, and Jacksonville; a 49% stake in Bowater Mersey Paper Company; and $333.3 million in marketable equity securities (as of 12/31/08), which includes $218.8 million of shares in Berkshire Hathaway. Whew.

To give a detailed intrinsic value that accounts for all these parts would require more work than we’re prepared to offer today. But let’s just focus on Kaplan. Kaplan generated 206.3 million in operating income in 2008, with 67.3 million in depreciation, and 15.5 million in amortization. After subtracting 99.3 million for capital expenditures, Kaplan had free cash flow of 189.8 million. In 2007, Kaplan posted free cash flow of 127.7 million; in 2006, 112.7 million. For now, let’s ignore Kaplan’s growth rate and the counter-cyclical character of the education business (McKinsey’s research shows a 90% increase in education spending during the past two recessions).

Looking at Morningstar’s numbers, we see that competitor DeVry currently trades at 18x FCF. Capella Education at 21x FCF. Career Education at 12x. Corinthian Colleges at 48x. ITT at 6x. Strayer at 28x. If we throw out the high and the low, we get a sector average of 19.75x FCF. Applied to Kaplan’s 189.8 million FCF, we get a value of 3.75 billion. As of 2/26/09’s close, the whole Washington Post Company traded for less than 3.5 billion.

Now, we recognize that to some, a 19.75 multiple on FCF may seem high. So tomorrow, we’ll take a closer look at the rest of the Post’s assets and give a more comprehensive estimate of its fair value.

Disclosure: I, or persons whose accounts I manage, own shares of Berkshire Hathaway at the time of this writing.