“Worst Case Scenario Valuation” for CPY …….

In the previous three posts I discussed the following points:

-reported earnings are substantially lower than operating earnings due to acquisition accounting

-sittings at Sears are still falling at almost a 10% clip and CPY can only raise prices by 5% so this is a serious problem, however EBITDA for Sears is still growing and both gross and sg&a margins are improving YoY

-CPY’s management will be using the Sears blue print for the acquired Wal-Mart business with a realistic chance that this company can generate $80M - $90M in EBITDA in 2010 and has a market value under $200M with $71M in net interest bearing long term debt

-Knightspoint (aka Ramius) increased their stake by 75% as the stock fell ….basically, very smart people who control the company and know the most about it are doubling down

Alright, here comes the fun part – what does valuation look like? In this post I will try to assign a “WORST CASE SCENARIO” price to CPY shares.

Here are my WORST CASE SCENARIO assumptions ……

-by the end of 2009 the PCA acquisition has proved to be a complete failure

-CPY’s management losses focus and the Sears business sees a decline in EBITDA to $40M per year – from $45M over the last 12 months -- so FCF comes in at $26 ($40 - $5 Capex - $9.2M in tax assuming $14M in D&A) in 2009

-there is no improvement in Wal-Mart EBITDA for the next two years (I think this is extremely conservative since they will surely improve EBITDA by just closing underperforming stores)

-CPY is forced to sell the Wal-Mart business at ½ acquisition price of $82.5M + ½ of the money invested in digital equipment which is targeted to be $38M …..non of PCA’s NOL’s are used or valued under this scenario

Under this worst case scenario, over the next 2 years CPY would use most of its FCF for the digital upgrade at Wal-Mart. CPY would than sell the Wal-Mart business at ½ its total investment and be left with just the Sears business which is now earning less due to loss of focus. Here is how the numbers look……

(I know that the picture is hard to read .....if you double click on it it will enlarge....if you want the excel version shoot me an email at offthebeatenpathinvestments@gmail.com)

Unless I am completely missing something, at current price of $25 per share we get to buy a stock that will have an estimated cash yield of 13% even if a lot of things go wrong. At $21 per share the forward cash yield is at 15%. If you are targeting a cash yield of 10% your buy point is $34 per share which is 20%+ above trading price.

* 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.

Knightspoint is loading up

October 16, 2007 …………From the filling ……..

New total Knightspoint ownership increased to 1.850M total shares or 29%. Knightspoint continues to add to their position as the stock is falling!

September 10, 2007 ………..From the filling ………..

Announced that Knightspoint (through other entities they control) has purchased an additonal 536,750 shares worth $23.1M. The stock was bought between 9/10 and 9/12 at an avg price of $43. This brings their total Knightspoint ownership to 1.598M total shares or 25%.

Here is a Bloomberg GPTR screen that plots insider buys (green arrows) against the stock price.

These insider purchases indicate that the largest investors in the company, who also happen to have the most insider information, control CPY's future and cash flows, and happen to be sophisticated financial buyers just increased their position in the stock by 75% as the stock is falling off a cliff!

Enough said.

* 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.

Key points from Q2:2007 Conf Call

Here are my notes from the CPY conference call ….

In my previous post, I adjusted EBITDA for the $8.1M in unbooked revenue. It looks like reported eps was $1 per share lower than operating eps …

"Our overall second quarter results were significantly negatively impacted as a result of purchase accounting adjustments associated with our acquisition of PCA, which closed on June 8. The overall acquisition negatively impacted per share results and net earnings by $1 and $6.4 million respectively."

Looks like sittings will continue to decline in the next quarter. Keep in mind that this was stated on August 29th so the quarter is over by now ...

"The preliminary net sales for the Sears Portrait Studio Division for the first four weeks of fiscal 2007 third quarter represent an approximate 5% decline over the comparable period ended August 19, 2006."

Guidance on digital conversion .....

"We plan to convert up to 400 PictureMe Studios to digital technology before the 2007 holiday selling season. The balance of the US studios are planned to be converted prior to 2008 busy season with the conversion of the Canadian and Mexican studios to follow in 2009. Preliminary estimates of capital requirements to complete the PictureMe integration, over $15 million in 2007 and $23 million in 2008."

Below is the most important portion of the conference call because it show how investors and CPY's management are thinking about the PCA acquisition as well as the attractiveness of CPY shares ones the PCA business is fully integrated by the end of 2009 ......

Q: “Quickly on the PictureMe integration, just thinking about the acquired business back of the envelope there is roughly twice as many studios each of which is delivering about half the revenues as SPS, gross margins are a little bit lower but not that much. Is there really any reason given that the per studio CapEx should sort of come down pretty rapidly given that technology curve since you did the same thing at SPS. If there any reason structurally why the ability to extract free cash over time from PictureMe should be at all inhibited related to the experience at SPS?

A (from CPY CEO): Obviously, that was the part of the attraction to us being able to acquire those assets, as we talked about on previous calls may have the ability to significantly leverage our corporate infrastructure here to realize the cost synergies that make this makes sense but in addition we are confident that by installing digital technology, training the PictureMe associates in the digital technology and having access to the unrivalled foot traffic that you do have in the Wal-Mart stores, that what you just described would certainly be our expectation.

Q: And just sort of thinking back to where we are now with SPS in terms of free cash flow, looks like in the trailing 12 months your somewhere between 40 and $45 million of free cash flow out of SPS.

A: Right

Q: If that doesn’t erode too awfully much over the next couple of years, once we get into ‘09 and you are through the CapEx injection into Picture Me. If we start getting similar free cash flow numbers out of those Picture Me studios, we could be talking about 80, $90 million of free cash flow being delivered by the whole company and yet we’re sitting here looking at a market cap under $300 million, which just strikes me as unbelievably attractive."

Here is the best part ........the cash flow projections have not changed but the stock has been cut in half since the conference call to roughly $160M.

What’s the next level after “unbelievably attractive?”

* 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.

CPY Q2:2007 Earnings Analysis

By just about any measure, CPY has been a pig of a stock. I first posted about it on 6/11/07 when the share price was $71. I have bought shares for the Marketocracy Best Ideas portfolio at an average price of $40.75 and the position now makes up 5% of that portfolio. I have bought shares for my personal account at $45, $40, and $30.5. Any way you look at it, this has been a bad investment thus far.

Obviously, at this point the question is do I cut my losses, do I add to my position or do I hold on. The next few posts will concentrate on CPY and I hope that I can come up with a reasonable answer.

First, the latest quarterly earnings analysis …….

The company reported fiscal Q2 earnings on 8/28/07 with this being the first quarter that included 6 weeks of results from the acquired Wal-Mart business. In their fillings, the company is calling the Wal-Mart business “Picture Me” and the legacy Sears business is called “SPS.”

GAAP reported net income in the quarter is NEGATIVE $3.4M vs. +$0.64M last year. However, it looks like the reported GAAP numbers are substantially understated. As I understand it, the company essentially booked 3 weeks worth of revenue from Picture Me--deferring $8.1M worth of revenue--but full 6 weeks worth of expenses.

Below is a breakdown by business line and what actual EBITDA looks like once the $8.1M deferral is added back:

The real bad news is that Sears continuous to see declining sales with sittings down 9.4% while avg price per order was up 4.8% for a net Sears revenue decline of 5.6%.

The good news is that despite the sales decline management is finding more costs to cut and EBITDA is still growing. Sears EBITDA was up $2M in absolute terms. Sears EBITDA margin up to 14.5% from 10.1% in Q2:2006. Margin improvement came from BOTH GROSS AND SG&A MARGINS.

Interest expense increased as the company is now carrying $115M in debt. D&A increased due to the acquisition. The 10Q stated that D&A from the PCA acquisition will be $14M annually.

From a purely financial perspective, I would say this quarter was substantially better than it looks. The Picture Me business will probably continue to distort earnings for another few quarters as CPY’s management starts to upgrade to digital, raise prices, and starts cutting costs – basically they will follow their Sears game plan from a few years ago. Negative sitting continues to be a concern, however average prices per customer are still rising and EBITDA is still growing.

In the next few posts I will highlight key points from the conference call, talk about the massive insider buying activity, and how I am looking at valuation.

* 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.

FTAR.ob -- 3Q Earnings Analysis

FTAR announced Q3 : 2007 earnings last week. Here is the quick breakdown of reported earnings

Q3:2007
Rev $148 (down 3.8%)
GP $44.2 (GM up to 29.9% vs. 29.8% last year)
EBITDA $7.2M (down from $7.7M last year, EBITDA margin down to 4.9% vs. 5% last year)

YTD 2007
Rev $455M (down 6%)
EBITDA $32.9M (up from $30.8M)

When I last wrote about the company I stated that

“next quarter I will be watching for the trend in SSS, K-Mart closings, and EBITDA margin improvement”

While it looks like the sales decline is slowing, there is still a sales decline with SSS at Shoemart down 1.8% and store closings of 0.4%. While it is disappointing I can’t say that I am entirely surprised taking into account the warm winter and consumer spending problems at the low end shopper.

The big disappointment for me was the decline in EBITDA margin. FTAR has been able to offset the decline in sales with continued operating improvements but it looks like they finally ran out of places to cut cost. Not even the best mangers can keep swimming against the tide of negative sales growth – looks like this is the first quarter where this has caught up with FTAR.

So …..sales are down, store count is down, warm weather means less need for new shoes, FTAR’s customers have less money in their pockets, and cost cuts are not keeping up with sales declines ……WHO CARES?

FTAR is still going to generate somewhere between $15M and $25M in free cash flow in Q4 of 2007 and another $30M - $60M in free cash flow in 2008. It will sell its headquarters for north of $20M and already has $15M in cash. With K-Mart having to buy all its inventory at book value at the end of 2008, FTAR is worth somewhere between $5 per share (worst case scenario which assumes some very bad developments) and $8 per share (best case scenario that is way bullish).

In the following quarter, my expectation is that sales well be down roughly 5%. The thing I will be watching is how badly EBITDA margins get hit. Will they continue to fall or will management continue to work its magic.

* 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.

Watching the sun set ......

While I hate classifications like "value investor" and "growth investor" because by definition every investor is a value investor, if I had to put myself one group I would be in the value camp. I don't think its a stretch to say that just about every value investor is keeping an eye on publicly traded homebuilders as they have been decimated and there will undoubtedly be a very attractive investment opportunity.

The question is .....when?

I will not attempt to predict a bottom in the housing market and homebuilder shares ....not now, not ever. What I will do is share a short "anecdotal" list of things I am watching for to let me know that we are closer to the bottom than the top:

1) multiple bankruptcies of the weakest most leveraged players
2) insider purchase activity at the leading players in the industry
3) large net income losses and massive write-downs
4) largest players in the industry trading below $10 per share
5) politicians become "unanimously outraged" at something
6) nutty valuations

While this list is not in any specific order, my experience has been that when the bubble bursts and things really get hairy, the weakest players are the first to go. We got news on Friday that LEV has filled for Chapter 11. Also, the good people at Calculated Risk report that BZH is having a hard time paying some of its sub-contractors -- not technically a bankruptcy but close enough. My guess is that CHCI and TOA are next.

Points #2 - #4 are fairly straight forward. It looks like the chairman of NVR--probably the most attractive publicly traded homebuilder--just bought a bit over $1M in stock on the open market. Also, I know that I have provided zero evidence that a sub $10 stock price is anything but an arbitrary number and has any meaning what so ever but my experience has been that when this happens across an industry it's a good time to start looking and doing some non-arbitrary research.

Point #5 is a bit trickier but I am basically watching for bipartisan agreement that something bad has happened. When politicians can loudly agree on something it means that the problem has fully materialized and the public has experienced all the consequences -- meaning that the problem is old news, has been priced into the market, and savvy investors have started looking ahead. While its hard to state exactly what the government will do regarding the housing implosion there is no shortage of politicians giving their unanimously outraged opinions on the issue. Watching the Bernake testimony this Thursday reinforced the feeling that politicians are unanimously outraged at what has gone on and are itching to do something that can be used as tangible evidence to their constituents that they are outraged and are doing something about this outrageous outrageousness.

Point #6 should not be on this list because there is nothing anecdotal about it. This is the hardest thing to see and requires a lot of non-arbitrary number crunching. I will be doing more work on NVR (and posting it here) and maybe one or two other publicly traded homebuilders to get an idea of what price represents a truly crazy valuation.

Using my list, if one can apply the old adage that "its always darkest before dawn" to the publicly traded homebuilders than we are watching the sun set and its getting noticeably darker outside.

* 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.

Earnings estimates for BOOT going up .......

Looks like the only analyst that publishes on BOOT finally raised his/her estimates.

Full year 2007 EPS estimate increased to $1.17 from $1.12
Full year 2008 EPS estimate increased to $1.32 from $1.29

Based on my last post on BOOT, I think these are to conservative. One of the most often cited behavioral biases effecting equity investors (and analysts) is under-reaction to new information. One of the reasons I am bullish on BOOT is that I believe that after years of underperformance, investors are not changing their expectations fast enough and the market price does not fully reflect the strong earnings momentum that the company has enjoyed.

* 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.

New CEO Appointed and INFS no longer on the selling block

As I have not posted in a while, I am going to catch up on major changes in the companies I analyzed for this blog and are in the Offthebeatenpathinvestments Best Ideas Marketocracy portfolio (and more importantly my own portfolio).

Looks like INFS appointed a new CEO and decided that the acquisition offers it received are not good enough. I am not particularly surprised that no deal went through and I wrote that I expect that much in one my original posts on INFS:

“ ….my feeling is that it would be hard for any CEO to justify buying a money losing operation even if he/she feels there is value to be added. Also, since Caxton is actively involved it’s highly likely that they would be looking for a very high premium – again, something most CEO’s could not justify to their boards, shareholders, or analysts.”

I don’t really have much more to add on this topic so will move on to the new CEO, Robert “Bob” O’Malley. Its amazing what a few hours and Google can turn up!

Here is an article talking about O’Malley’s departure from Tech Data. This article does not give me much confidence in the new CEO of INFS. It's full on “cover your ass” complements and ambiguities but short on any results attributed to O’Malley.

Phrases like this usually make me cringe: “O'Malley was an anchor” ……” He was driving a lot of the initiatives” …..WHAT THE HELL DOES THAT MEAN?

Here is O’Malley’s work history prior to INFS that I pieced together:

3/2005 – 9/2007, Tech Data -- VP of Marketing
10/2002 – 3/2005, UNKNOWN
10/2000 -- 10/2002, Immersion (IMMR) – CEO
6/1999 – 7/2000, Intermac (sub of UNA) -- President
1998 – 4/1999, MicroAge -- CEO of Pinacor
5/1995 -- 1998, MicroAge -- President of MicroAge Data Services
1/1976 – 5/1995, IBM -- Left as President of Desktop PC division

O'Malley's track record gives me even less hope than the praises of his Tech Data colleagues.

O’Malley was effectively fired from Pinacor in 1999 after being the CEO of that company for little over a year. He was actually moved to the Board of Directors but that’s what small companies do to CEO’s whom they want to fire to protect their public and industry reputation.

On his watch, Pinacor lost its biggest customer, Compaq, which accounted for 26% of sales at the time. It should be noted that Compaq fired a lot of distributors as it cut the number from 39 to 4. It should also be noted that Tech Data was a direct Pinacor competitor (they were one of the 4 that Compaq kept) and did end up hiring O’Malley which is somewhat of a sign of confidence. (http://www.crn.com/it-channel/159402582)

Still, Pinacor was one of the biggest in the business at the time and it’s the CEO’s job to protect key relationships.

O’Malley than turned up as President of Intermac and resigned 1 year later to move to Immersion. He lasted 1 year at Immersion. I was not able to find any more info on his employment between Immersion and Tech Data.

As I see it, this guy fashions himself as a CEO but was only able to last at management jobs at IBM and TechData – two behemoths where underperformers can slip through the cracks for years. His did not last more than two years at 3 small technology firms that he was given to run.

From his track record, there is not one shred of evidence that this guy can manage -- much less turnaround -- a small, money losing company that faces an onslaught of competition. Running INFS is a completely different challenge than a cushy marketing job at Tech Data or a management job at the mother ship, IBM.

I can’t believe this guy was actually compared to Michael Dell at one point.

This appointment basically says that either 1) Caxton did not do as much research on O’Malley as I did (which I seriously doubt) or 2) INFS is in so much trouble that O’Malley is the only guy they can find to run the company.

Either case is not an attractive proposition for INFS shareholders.

This appointment is making me seriously rethink my investment in INFS and I am considering cutting my losses.

* 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.

Thoughts on BOOT article and furniture stocks

A nice article about BOOT from the The Oregonian. Thanks to joeletaxiiii from the yahoo message boards for the link.

The article briefly discusses how BOOT was able to engineer a turnaround over the last few years by getting out of low priced, low margin, commodity like businesses and re-focusing itself on producing super premium products and reinforcing its brand names.

While its nice to see this company get some ink, I discussed most of these points in my initial posting on BOOT. Still, this article did get me thinking about what other industries are prime candidates for reworking their business model and moving upmarket.

One industry and a number of publicly traded members of that industry that seem to be perfect for such a change are U.S. based residential furniture manufacturers. This industry has been decimated by foreign competitors that produce a much lower quality product but price it so cheap that it makes sense for the consumer to replace their shaky tables and squeaky sofas every few years rather than paying a premium for a higher quality product.

However, I believe there will always be a large opportunity for the higher end producers as everyone eventually gets older and wealthier and at some point you simply want to own a quality product that will last a lifetime and you are willing to pay a premium for it.

I think there is a big enough space between the low end and the super super high end parts of the market for some of the U.S. based manufacturers to dominate and produce a sufficient return on capital. A couple of names in this beaten down sector look interesting but require more work are FBN, ETH, and HOFT.


* 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.