BOOT -- “Final Thoughts”

Just to recap, BOOT has really turned around their operations over the last 4 years and has seen substantial margin improvement. However, the company continues to have operating margins below the industry medians even after the increase in recent years.

My favorite way to look at valuation for small cap turnaround stocks is
1) ATTEMPT to calculate a price that a larger public competitor would be willing to pay
2) ATTEMPT to calculate a price that I would be willing to pay for the business

I find this to be a good exercise for those stocks that have publicly traded peer groups. This allows me to calculate a rough buy and sell price, but that’s the smaller benefit. The bigger benefit is that it clearly highlights discreptencies between what I think is the right price and what the market thinks is the right price for a group of similar stocks.

I am going to spend a lot of time talking about what BOOT would be worth as an acquisition candidate. However, I want to reiterate that ITS HIGHLY UNLIKELY THAT BOOT WILL BE ACQUIRED.

Why would the CEO agree to sell the company when his family owns half the shares and the board is made up of his father’s friends? While the current management has added a lot of value since they took over in 2000, the fact remains that “shareholder accountability” is nothing more than lip services. The CEO knows that the board will keep paying him a million bucks a year even if BOOT’s operating performance continues to lag the industry.

Enough with the background noise ……. Is this stock going into the Best Ideas Portfolio or is it getting trashed into the Watch List Portfolio?

Using the peer group that I described earlier we can calculate that sales growth for the last 3 years has been 9.7% annually and EBITDA margins were 13.5%. If we make a very naïve assumption that the group will grow at that rate for the next 3 years and maintain the same margins than the industry is trading at following forward valuations

P/FWD 2007 EBITDA …… 9.48x
P/FWD 2008 EBITDA …… 8.65x
P/FWD 2009 EBITDA …… 7.89x

If we assume sales growth of 8% for BOOT over the next 3 years and its takes 3 years for the acquirer to get BOOT’s EBITDA to industry median levels than the valuation looks something like this:

P/FWD 2007 EBITDA …… 8.07x
P/FWD 2008 EBITDA …… 6.83x
P/FWD 2009 EBITDA …… 5.83x

You are looking at discounts of 25% to 35% to industry levels. To get in line with industry valuations that stock would have to be trading at $23 to $21.5 per share. Haircutting that price by 30% to provide for a margin of safety I get a peer group derived buy price of $16 to $15 per share -- which is a bit lower than the current price of $17.10 per share.

So far so good …….But what would I be willing to pay for BOOT?

Since I don’t have $100+ million I will have to borrow the entire sum. Let’s say I can borrow at 7% (I think most of the peer group I use would be rated A to BBB+ so they would be issuing 10 year paper at roughly Treasury yield + 100bps which gets us to about 6.15% but lets be conservative).

Using the same forward 3 year assumptions as under the peer group analysis, I calculate that I can pay $31 per share for BOOT and if my assumptions are correct I will still break even after 3 years. The $31 target price implies 80% total return and 22% annualized over next 3 years. I think the $31 share price is the highest possible price BOOT can be trading at over the next 3 years.

But I don’t want to just break even, I want to earn a satisfactory rate of return. For me to get a 10% rate of return on this investment I would have to pay no more than $20 per share to acquire BOOT. Haircutting that price by 30% to provide for a margin of safety I get a buy price of $14 per share -- which is almost 20% lower than the current price of $17.10 per share.

Its pretty clear that I don’t think that BOOT is wildly under or over valued. I think the stock is trading roughly in line or at a discount to where others in the industry are trading. Unfortunately, it’s not trading low enough to provide me with a large enough margin of safety to initiate a position at this time. I will be adding the stock to the Watch List portfolio and will be waiting for new data or a lower share price.

Going forward, I will be watching for trends in gross margins and SG&A as % of sales and if revenue is trending above or below the 8% level set by management as the goal.


* 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.