“Best Case Scenario Valuation” for CPY …….

In the previous post I laid out a valuation framework using what I feel are very bearish assumptions with the conclusion being that buying the stock anywhere between $21 and $34 per share provides for expected rate of return of 15% to 10%.

Today I will silence my inner and ever present skeptic and will try to put some numbers on what the upside looks like assuming some good things happen over the next few years:

BEST CASE SCENARIO assumptions ……

-EBITDA at Sears would stay flat over the next two years (not all that bullish as EBITDA has been growing over the last 2 years)

-immediate incremental improvement in Wal-Mart EBITDA (not all that bullish as EBITDA can be drastically improved by simply closing underperforming stores)

-Wal-Mart would eventually achieve similar margins as Sears and FCF would double (very bullish assumption as the Wal-Mart business serves a lower end consumer at lower average sales price)

-PCA is not sold under this scenario, so the NOL’s that came with the acquisition can be included in the valuation analysis

Under this best case scenario, the CPY shares would trade at $90 per share assuming a 10x EV/FCF multiple. At a 7x EV/FCF multiple the shares would trade at $60 per share.

The best and worst case valuation scenarios I laid out highlight why I am so bullish on CPY over the next 3 years. Based on worst case assumptions, the stock has very little downside of 20% at which point you would be buying the CPY business at 7x free cash flow. However, the upside is up to 200% assuming the company’s management can do with the Wal-Mart business what they did with the Sears business.

As I see it, as an investor in CPY shares for every $1 in downside risk I am getting $9 in upside potential ….and that’s pretty damn 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.

“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.

CPY Q1:2007 Earnings Analysis

CPY reported first quarter earnings on 6/5/2007. Based on my previous post this is what I was looking for while reading the release:

“…….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 …..”

The trend in Sears sitting continues to be negative with sittings down 13% while the trend in sales per customer continues to be positive with sales per customer up 11%. Overall, net sales were down 4% and the fact that the increase in sales per customer is not offsetting sittings decline is a bearish sign. However, I can make a strong case (at least to myself) to own the stock at the right price without growth in Sears sales so this continued sales decline is not monumental.

EPS increased 40% YoY to $0.40 per share with most of the increase due to a mysterious 9c benefit for a “change in vacation policy.” Its unclear to me if we can expect an additional 9c in each of the remaining quarters or is this a one time deal.

It looks like the second quarter is going to experience the same trends in sitting declines. The company reported that for the first 5 weeks of the second quarter sitting are down 10% YoY and total sales are down 4%.

On the PCA front nothing groundbreaking was disclosed. If you listen to the conference call the only thing worth noting is that it looks like management will start working on converting the studios to digital right away. It looks like the expectation is to do some in 2007 and finish up most if not all by 2008. I mentioned this in my earlier post as “a given” but it’s nice to have a confirmation on this anyway.

The only other thing that was mentioned is that management feels they have the capacity in place already to service all of PCA’s digital infrastructure. The implication is that margins are going to improve with addition of PCA. While this is a nice thought, I am waiting to see the numbers to incorporate this into my projections.

Knightspoint did not sell any shares and GAAP dep/amort continues to be substantially higher than maintenance CAPEX.

Overall, this quarter did not provide any info that would cause me to change my opinion on the stock. If the stock falls below $65 per share before any meaningful PCA info is disclosed I am going to start nibbling, otherwise I am taking a wait and see approach.

Things I will be watching for in Q2:2007 remain the trend in Sears sitting and sales per customer, difference between CAPEX and reported dep/amor, insider trading by Knightspoint, new info regarding PCA. Also, I will be looking to see if the vacation policy change will have the same positive effect on Q2 as it did on Q1.

Oh yeh ….. it looks like CPY continues to be underfollowed. Only two people asked question on the conference call despite the big announcements and sharp share price increase in the last 3 months. There maybe an opportunity for us in CPY yet …….

* 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 -- 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.

CPY -- “Da Bears” Part II

Up to this point I have purposely ignored the recently announced acquisition of PCA (Portrait Corporation of America) since I was not sure if it should go into the bullish or bearish column.

On May 2nd CPY announced that it has won the right to acquire PCA out of bankruptcy for $100 million in cash which CPY will borrow. This is what ultimately gapped the stock up from $53 to $75. Based on the market reaction, investors believe that the PCA acquisition is going to be an immediate positive and justifies an immediate 40%+ increase in the share price.

Ultimately, I think this is going to be a successful acquisition for CPY and based on their recent execution I am willing to give them the benefit of the doubt to a certain extent. However, the RECENT PRICE MOVE HAS REMOVED ALL OF THE MARGIN OF SAFETY from CPY (the 8k that was filed on May 25th has no operating details about PCA’s business).

Here is why …….

Current Market Value at $78.50 per share: $500M
Last 12 months EBITDA: $44M
Current MkValue to EBITDA: 11.3x
Current MkValue to EBITDA of SPX: 9.9x

Last 12 months NI (replace $17M in Dep with $5M in Capex) = $28M
L12M P/E = 17.6x
S&P 500 L12M P/E = 17.7x (Reuters estimates data)

Based on this naïve valuation, CPY is trading in-line or at a 15% premium to the S&P 500, while my guess is that it should be trading at a discount (more on this later).

What self respecting analyst looks at last years results, you say. Stop leaving in the past man and look into the future, you say. Have a little vision, you say. Ok, lets play with some numbers to get an idea of what the current $78 share price implies about future earnings.

Current S&P 500 forward multiples are …….
2007 S&P 500 P/E = 16.5x
2008 S&P 500 P/E = 15.4x
2009 S&P 500 P/E = 14.1x

At the current price, for CPY to have a 2009 forward multiple similar to the SPX the company must earn $35M in net income. Let’s say you agree with the negative issue I raised in the previous post http://offthebeatenpathinvestments.blogspot.com/2007/05/cpy-da-bears-part-i.html and want apply a 30% margin of safety you are looking at a 2009 fwd multiple of 9.9x which implies net income of $50M.

My biggest problem with CPY at the current price is that I think the lack of information about CPA’s financials combined with the recent success management has had executing the Sears business turnaround has caused an over reaction to this announcement.

The only thing that was disclosed in the fillings dealing with the acquisition is that PCA has $290M in revenues which is almost identical to 2006 revenue at CPY. I think that the initial back of the envelope analysis would imply that in a couple of years management can work their magic and net income double which gets us to $50M and a multiple that is at a 30% discount to the broad market – when I looked at this stock I did exactly these calculations and thought that it was still pretty damn cheap despite the big pop in price.

And they are now the sole provider of photography to the world’s biggest retailer? What’s not to like.

In the next and concluding post on CPY I will try to highlight why this back of the envelope valuation is not enough to justify a purchase and try to put some kind of target price on the stock ……..

* 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 -- “Da Bears” Part I

Despite the three part bullish case for an investment in CPY there are some real areas of concern. The one sentence bearish case would be that the company is still experiencing double digit sitting declines, the CEO hired in 2005 to lead the company abruptly left in 2006, and the recently announced acquisition represents a large unknown.

No matter how long I look at the improvement in operations over the last few years and how rational and shareholder friendly the board and management action have been, I still can’t seem to ignore the elephant in the room -- that the number of customers walking through the door has been falling at double digit rates for the last two years. In the most recent fourth quarter, which generally represents 35% of annual revenue and 100% or more in annual net income, the company saw seating decline by 12% and in the year before sitting fell 17% (full year sittings in 2006 fell more than in 2005 but the fourth quarter is the only one that matters). Based on announced first quarter revenue guidance, it looks like we can expect more decline in sitting volumes.

I believe the company when they say that the decline in sittings is orchestrated and that the customers they keep are far more profitable than the ones they lose but I still have a hard time seeing how earnings are going to increase at any meaningful rate. Eventually the company’s undesirable customers will run-off meaning that the growth in revenue per customer will fall drastically. I also have a hard time envisioning the customers that do stay accepting yearly price increases at any meaningful rate.

With no wind in their back, to show any semblance of growth this company has to constantly introduce new products and price their products perfectly, essentially they have execute flawlessly -- this is a rare occurrence and I would not bet on it. Without growth there is no multiple expansion.

Another disconcerting aspect of this investment is that the newly higher CEO Paul Rassmusen suddenly left the company. This seems odd in that he would leave a senior position at Kodak, relocated to take the job in mid-2005 and than leave a year later. I would be much less concerned if he left for a ginormous pay package at another company, but based on Google searches I can’t seem to find where he landed. A publicly traded company would have issued a press release. The CEO was immediately replaced by Renato Cataldo who was originally brought in as a consultant during the early days of the re-org and took a position in 2005 as COO. I am not sure exactly how bad of a sign this is since its obvious that the guys at Knightspoint are still making the big decisions, but it is certainly not a positive to have such a high rate of turnover at the top post.

On top of all this, professional photography is still a discretionary item and demand will fluctuate with overall consumer spending. Yes, you are still going to get pictures of the new baby taken to send to grandma but you may only pay for half as many prints if times are tight.

Also, much like FTAR (http://offthebeatenpathinvestments.blogspot.com/search/label/FTAR) the company still only has one customer and has much less control over its destiny. However, that may be changing ……


* 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 – “Da Bulls” Part III

The first two bullish posts covered the company’s shareholder friendliness as well as the company’s vision for the future. In this post I will cover CPY’s cash generation ability and why I think cash generated is higher than stated GAAP net income.

If the company can maintain its current level of revenue and profitability, CPY’s can generate $44 million in EBITDA.

Revenue $294
EBITDA $44

From here it gets interesting as reported depreciation/amortization was $17 million but CAPEX was only $3 million. The company actually expected to have $5 million of CAPEX in 2007. It’s a little difficult to guess the exact level of CAPEX going forward since the company basically threw out a lot of its old equipment which consisted not only of cameras but the equipment needed to print the pictures and fill the orders. However, it looks like managements guidance for CAPEX is $5 million at least for the next few years. At $5 million of CAPEX and a 40% tax rate applied to this higher cash flow …..

EBITDA $44
CAPEX $5
TAX $15.6
FCF $23.4M or $3.67/sh
Reported GAAP Net Income for 2007: $16M or $2.60/sh

I think my estimate of FCF is actually conservative by about $5M for at least a few years since the company will pay less taxes on the lower net income than what I calculated here.

What about working capital? Interestingly, it seems that unlike the department stores that they do business in which must spend cash upfront on inventory to growth, CPY actually has NEGATIVE working capital. This largely comes from the fact that they carry almost no inventory and very little receivables but they do take deposits upfront from their customers (there are broken out in the 10K but are probably lumped into “other CA” everywhere else).


* 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 – “Da Bulls” Part II

The second bullish aspect of this stock is that they seem to have a clear business strategy and more importantly have the balance sheet to execute their plans.

As it stands now, two major tiers have emerged in the professional photo industry with the bottom of the group competing solely on price mainly by offering larger/more prints at discounted prices as well as instituting “no session fee” policies. The top of the group is competing more on quality, service, and number of choices but at higher prices.

Reading through the last 2 annual letters to shareholders penned by David Meyer who is the Chairman of the Board as well as the co-founder of the investment firm that led the hostile takeover in 2004, it becomes obvious that the key CPY’s long-term strategy is to be in the top tier by preventing the commoditization of their products. While digital photography has caused some pain for the company, it is now seen as the best way to achieve long term growth and profitability. Pretty ballsy ……

I am not going to quote extensively from the Chairman’s annual letters but they are important to read to understand what the guy calling the shots is thinking, they are also refreshing compared what these letters usually sound like. Here are what I feel are the most notable quotes:

2004 letter: “digital has arrived, and there is no looking back”
2004 letter: “our customers are not inherently price sensitive when it comes to genuine
differentiation”
2005 letter: “despite facing an aggressive promotional environment, we will not
participate in the commoditization of our valuable service”
2005 letter: “I am frequently asked if I am concerned about our sittings declines. The
answer, candidly, is no.”

(link to annual letters: http://phx.corporate-ir.net/phoenix.zhtml?c=103013&p=irol-reportsannual ….. the 2003 letter is missing for some reason)

I think these give a pretty clear indication of what direction management is going to take this company. I did not spend much time reading the letters from the pre-2004 management, but one quote did jump out at me and highlights the 180 degree turn in the direction of this company:

2002 letter: “In 2003 we will continue to focus on the fair price for the value and service
we provide, but we must also recognize that over the long-term, we need to get new Moms to try us.”

To me this is a nice way of saying that we are going to slash prices to get more people through the door and worry about profitability later. Oh yeh, the only operating target offered as a company stated goal for the following year was a revenue target with no mention of profitability.

Looking over the last 2 years operating results, it looks like management is doing what they said they would and is having some initial success. In 2006 and 2005 sitting volume (the number of customers walking through the door) declined 17.7% and 16% compared to the previous year. However, total revenue showed a small positive increase in both years due to a 22.4% and 22.9% increase in sales per customer due to introduction of new digital products and a price increase instituted in 2005. Yes, this company actually increased prices and customers came back!

Looking at the balance sheet, it also looks like the company has the financial wherewithal to fund its long term plans. AFTER spending $32 million buying back stock and roughly $35 million to upgrade its studios to digital the company is still virtually debt free with $27M in free cash and $16M in debt outstanding that will be paid off by 2009 and $23M in long term liabilities for legacy pensions. The company can generate roughly $25M in free cash flow (see next post for calculations), so if things stay as they are the company will have roughly $70-$75M in free cash on the balance sheet and no debt by the end of 2009.


* 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 -- “Da Bulls” Part I

The one sentence bullish thesis for CPY is that the company is shareholder friendly, management has the foresight and the balance sheet to grow the top line when the number of customers walking through the door is falling, and it looks like GAAP net income understates the company’s true cash flow generation ability.

Alright, lets take these one by one ……

Many company’s get labeled as “shareholder friendly” but it often means that the execs are buying you dinner before they have their way with your company. Things like stock buybacks, management’s vision and execution are NOT shareholder friendliness – this is what management is supposed to do! What is shareholder friendly is to have executive compensation aligned with shareholders.

Reading CPY’s proxy statements over the last 3 years one quickly gets the feeling that management knows exactly what is going to make them richer. For example, lets take the 2005 proxy and look at the Executive Compensation discussion, here is what we will find:

“Under our new performance plan, executives and other participants have the potential to earn significant gains in overall compensation, if pre−established, objective targets are met and exceeded. For fiscal year 2005, the incentive pool from which all awards were drawn (from the Chief Executive Officer on down) was determined on the basis of EBITDA generated by the Company. ….. The Board of Directors resets the EBITDA targets each year to provide performance awards designed to yield corresponding growth in stockholder value. ……..The Company exceeded pre−established performance benchmarks for fiscal year 2005. Accordingly, recipients throughout the organization, including hourly and salaried employees as well as key managers, were recognized and rewarded for their individual contributions. Importantly, a substantial portion of the total awards was paid in restricted shares, thus aligning the interests of our employees with those of stockholders.”

It appears that this board of directors understands the concepts of profitability, inflation, and that if you are not going to compete on price than share the wealth with the people actually servicing your customers.

The now ex-CEO that was hired in 2005 received 50% of his bonus in restricted stock that will not fully vest until 2010. The company states that non of the key execs have received base salary raises in the previous three years which further focuses them on the level of the stock.

Here is another golden nugget from the 2005 proxy:

The employment agreements for these executives [these are the guys that cashed in and also got canned after Knightspoint took over] also provide that following a Change of Control, the executive is entitled to a base salary at least equivalent ….[you know how the rest goes] ……The employment agreements for Mr. Rasmussen [at the time the new CEO] and Dr. Cataldo [at the time the new COO and now the new CEO] do not contain Change of Control provisions.”

Oh yeh, the new CEO and COO don’t get a pension either.

The one negative I found in the proxy is that one board member and co-founder of Knightspoint awarded himself roughly $650,000 in CPY stock for a years worth of work which is embarrassingly small by Wall Street standards but is substantially higher than many of the other execs received. Why did this happen? Despite owning arpox 15% of the company, Knightspoint effectively controls CPY due to the structure of the board of directors. Since 2004, they lowered the number of board seats to 5 from 9 when they took over and of the 5 seats they control 3.

All in all, this is pretty clean and provides a lot of evidence that management is on the side of shareholders. The proxy for 2006 should be coming out within a few weeks and the compensation structure of the newly hired CEO will provide more evidence on how management is incentivised.

* 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 -- First Look

I initially discovered this company a couple of months ago when doing research on FTAR thinking that if shoe sales can be outsourced by major retailers why not photo studios, electronics departments, optical centers, etc. Unfortunately this company fell into the black hole I call my “watch list” and I forgot about it until I saw it pop up on the daily biggest gainers list as the stock went from roughly $57 to $75 on May 2, 2007.

Initially, I was attracted to the stock for the following reasons:
-operating cash flow on the CF Statement is substantially higher than reported GAAP net income for the last 2 years, despite the lack of large one time charges
-huge swings in CAPEX over the last two years
- dep/amort in 2007 substantially higher than CAPEX
-19% decline in shares outstanding
-solid balance sheet
-appearance of NEGATIVE working capital (is that possible?)

Currently:
Share price: $79
Market Value: $525
Enterprise Value: $536
Investment Type: Turnaround Situation

CPI Corp. (CPY) operates 1,041 professional photo studios in U.S., Canada and Puerto Rico which are located inside Sears stores (actually, 32 stores are free standing but carry the sears name). CPI has been operating photo studios for the last 60 years and has been Sear’s only photo studio operator since 1986.

There are several aspects beyond what is initially evident from the financial statements that are driving the share price. First, the company has gone through a major shake up since 2004. In early 2004, Knightspoint Partners effectively took over the company in a hostile takeover battle and proceeded to replace 6 of the 9 board members, lower the number of board seat to 8, and fire the CEO and his top 2 lieutenants. As a side note, it appears that Knightspoint is a grown up version of Ashton Kutcher. Based on this article from December 2003 it looks like the guy leading the charge was previously a paid advisor to the company when he was and ibanker at CSFB, now this is what I call getting punk’d. http://www.bizjournals.com/stlouis/stories/2003/12/08/story3.html

Second, it appears that professional photo industry in the midst of major upheaval driven by the advent of digital photography. In the last 24 months the company has effectively switched to all digital (there are a few studios in Canada that are still transitioning) which has required a major investment from the company -- more on this later. It also appears that two major tiers have emerged with the bottom of the group competing solely on price and the top of the group competing more on quality, service, and number of choices.

Third, the company announced that it will be acquiring Portrait Corp of America (PCA) out of bankruptcy which operates all the portrait studios located in Wal-Mart stores and up to this point was one of CPY’s biggest competitors. This announcement has major implications for the company that will be discussed in depth in later posts.

To be completely honest, I have done very little analysis up to this point and have basically summarized the major points from the 10K (http://phx.corporate-ir.net/phoenix.zhtml?c=103013&p=irol-sec) . I hope to change this with the next few post …….


* 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.