CPY -- Final Thoughts

To sum up, the bullish case is that management is shareholder friendly (as they are major shareholders) and they have had a lot of initial success turning the company around. The bearish case is that they are still in the process of a turning around, the recently hired CEO left, and they have recently announced an acquisition that has sent their shares soaring erasing all of the margin of safety.

I think it’s pretty obvious that I like this company and like what management is doing to turn things around, but when I consider all the things that can go wrong I can’t justify the current share price.

For starters, acquisitions are usually a bad deal for shareholders. Big acquisitions, like doubling the revenue of the company are even less likely to work out. Big acquisitions in an industry facing a lot of headwind is usually suicide.

Also, its not clear that management can execute the conversion to digital at PCA as smoothly as they did at CPY (I am taking it as a given that they will try to convert to digital). Yes, they are doing it a second time and will not make the same mistakes. But, they must convert 3x as many stores (PCA’s store count is 3,000 vs. 1,041 for CPY) which are more spread out geographically (PCA has stores in Europe and Mexico as well as Canada and U.S.). There are also many times more employees to re-train and supervise.

Furthermore, I think that the market is assuming that after a few years and the conversion to digital the margins of the two businesses will be identical so cash flow will at least double. I am not going to waste time speculating about this until CPY provides more information but with 3x as many stores and identical revenue this means that per store sales are 1/3 at PCA compared to CPY. I have a hard time seeing how they will be able to squeeze the same margins from each Wal-Mart store at 1/3 sales per store.

Plus, its not a given that CPY’s Sears business is out of the woods yet. They are still seeing sitting fall by double digit rates. They are taking on this huge integration as well as substantial debt load, while they are still turning around their core business. Needless to say that they will have to execute perfectly to meet expectations implied by the current share price and hope that consumer spending does not contract.

What would be the a good entry point given all these concerns? Again I am not going to waste time with this until there is more information but here are some basic calculations:

EBITDA from Sears in 2009 $44
EBITDA from Wal-Mart in 2009: $22 (Wal-Mart at ½ margin of Sears)
Maintenance CAPEX $10M
Interest Expense on $100M $8
Taxes: $0 (assume NOL’s since they are buying PCA out of bankruptcy and should come with losses)
Net Income in 2009: $51M

2009 S&P 500 P/E = 14.1x
Implied Priced = $106 per share

If the stock trades down to $64 per share which is the $106 implied price minus 40% for maring of safety, than I will consider buying even if there is no new information about PCA.

Things I will be watching for next quarter is the trend in Sears sitting and sales per customer, difference between CAPEX and reported dep/amor, insider trading by Knightspoint. Obviously any new information regarding PCA operations and terms of the debt that will pay for PCA will be watched for and will provide additional info.


* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.