FTAR.OB -- “Da Bulls” Part I

Before moving on to the rest of my post, the one sentence bullish thesis is basically that the agreement with K-Mart and the recent actions by management have provided for a limited downside with a fairly good possibility of positive absolute returns as well as a free 1.5 year option that is likely to expire worthless but can turn FTAR into a 3-5 bagger between now and end of 2008.

I am going to do my best to turn my spreadsheet into words but I suggest e-mailing me at offthebeatenpathinvestments@gmail.com and requesting a copy and double checking my figures (and letting me know if I made a mistake). To get to my price range of $3.5 - $7.5 I made some “worst case scenario” and “best case scenario” assumptions. By the way if anyone knows how to post excel spreadsheets into Bloger let me know.

In my Worst Case Scenario I am assuming that
1) sales fall 10% in 2007 and 2008,
2) gross margins decline in 2007 by 100bps from 2006 levels (100bps decline in gross margins is HUGE for a company with EBITDA margins of 8.1% in 2006) and stay the same in 2008, and
3) SG&A expense falls only 3% YoY, basically I am assuming that for a compounded decline of 21% in sales over next 2 years, SG&A only declines 6.1%

Bearish indeed …….
Those of you that actually look at the recent financials will say that a 10% YoY decline in sales does not sound very bearish when you consider recent trends in sales. I will point out that FTAR’s K-Mart business SSS (same store sales) have improved substantially with SSS in 2006 at negative 3.8% and SSS in 2005 at negative 7.5. Also, SSS were actually positive in Q1-2007 with +0.7%, however this is the company’s weakest quarter so it may not represent a trend.

Another reason why I think total and SSS will not be similar to the most recent past (and therefore a 10% decline would represent a Worst Case Scenario) is that K-Mart has gone through a re-org of its own and I am sure Eddie Lampert closes his worst performing stores first just like anyone else. Also, the actual number of FTAR’s K-Mart stores declined by 3 in Q1-2007 on track for 12 closed stores for the full year. In 2006 FTAR lost 29 K-Mart stores and in 2005 they lost 61.

In my Best Case Scenario I am assuming that:
1) total sales stay flat in 2007 and 2008 -- actually this is an assumption that SSS will be positive as its likely that there will be a number of K-Mart stores closed in that time, and
2) Gross margin increase by 50bps in 2007 and 2008 for a compounded increase of 1% over next 2 years, and
3) SG&A expense will fall by 1.5% in 2007 and 2008 for a compounded decline in SG&A expense of 3% on flat sales

While these assumptions are certainly bullish, they are not impossible. For example, on a rolling 12 month basis GM has increased in each of the last five quarters from 31.5% to 32.2% (again a 70bps move is huge for a company with EBITDA margins of 8.1%). Furthermore, SG&A as % of sales has fallen in each quarter from 26.5% to 24.1%.

Under the worst case I get FCF (assuming $2M in capex annually) of $30M and $16M which are worth $40.5 today discounted at 10%. Under the best case I get FCF of $59M and $61M which are worth $103.5 today.

But that’s not all folks, you also get all your inventory taken out at BV (not liquidation fire sale value) which I calculate as being worth $33M discounted at 6%. To get this I simply net A/R + Inventory against A/P and Accrued Expenses and discount.

If you call now, you will also get the estimated value of the non-K Mart business which is growing by the way, the company headquarters that are almost all paid for and the value of the NOL’s that FTAR has. Net out the liabilities as well as my estimate for $10M-$15M in liquidation costs and I get a price range of $3.5 - $7.5 per share.

At current trading price of $4.6 you get downside of 23% for upside of 64%, those are 3 to 1 odds from where I come from.

* DISCLOSURE: I or accounts I supervise are long FTAR.OB. This is not a recommendation to buy or sell any security. For informational and educational purposes only.