Cheap Industries

[Packer16]

I have been bottom fishing and have found 2 industries that appear to be hated with stocks selling @ low FCF ratios.  I would like to hear others takes in these segments as my industry insight is limited in for these industries.  The first is the US directory business.  There are 3 firms who compete in this space (Supermedia, DexOne and Yell) with 2 who have recently exited from bankruptcy (Supermedia and DexOne and FFH holding a sizable position in one (SuperMedia).  Supermedia is selling for less than 1x FCF and has had rising FCF over the past few years (2008 to TTM).  DexOne is selling for slightly above 1x FCF.  Both these firms are in declining indusrtries and have debt loads @ about 3 to 3.5x EBITDA.  Paulson also owns large stakes in these.  European comps (Yell and SEAT) have debt/EBITDAs of about 5x and trad for 1.5 to 2.0x FCF.  PagesJaunes in Froance has about 3.9x EBITDA in debt and trades a 9.0x FCF.  Has anyone been looking at these?

 

Another area is MMOG companies in China.  There are 2 that appear cheap Shanda Interactive and Perfect World (both 4 to 6x FCF).  Both are audited by PwC.  How does one protect yourself against fraud in China?  Look for reputable audit firms?  Second, has anyone looked into this space.  I looks like a great way to monitize gaming and not have to worry about pirating.  It appears to be popular with the teen age croud.  Any comment appreciated.  TIA.

 

Packer

[ExpectedValue]

Another area is MMOG companies in China.  There are 2 that appear cheap Shanda Interactive and Perfect World (both 4 to 6x FCF).  Both are audited by PwC.  How does one protect yourself against fraud in China?  Look for reputable audit firms?  Second, has anyone looked into this space.  I looks like a great way to monitize gaming and not have to worry about pirating.  It appears to be popular with the teen age croud.  Any comment appreciated.  TIA.

 

Packer

 

One thing to keep in mind whenever you see something like PwC or another big auditor listed is to see if they are lending their name to a smaller local audit partner. Sometimes it will say PwC XYZ - the XYZ being the name of their local Chinese audit partner. If things ever go wrong and there is a fraud they can simply shift the blame to XYZ.

[twacowfca]

Packer, I respect your acumen.  How do you project cash flows, especially those that will be truly "free", after all the debt might be paid off for highly leveraged companies that appear to be in declining, if not "buggy whip", businesses?

[T-bone1]

I have been buying a few businesses of this type, including ELNK, FTR, and SPMD . . .

 

The very brief version of my thesis is that the customers who stay get more and more "sticky", just like what happened in the pager industry. If you are still using Earthlink dialup, the yellow pages, a rural landline, etc you aren't likely to stop this year. There will still be attrition every year, but the clients that remain next year will be more "sticky" as a whole than the clients this year were, creating a long tail.

 

These businesses can cut costs (basically lay people off) each year as their customer base declines to maintain margins (I think SPMD's margins have ticked down from 35% to about 30% over the last five years, which is pretty good considering expectations).  SPMD is also in the proccess of getting approval from individual state public utility commisions to stop printing the "people" white pages. This will eliminate a major cost for them.

 

 

[elltel]

Yell, is owned by Shah who took over from Bolton on the Fidelity Special Situations Fund. He loves the stock and says it is the perfect contrarian play... jury is out though as he probably nursing losses on his holding.

 

he owns 38m shares.

[Myth465]

I dont know. I dont like these types of companies because time is not their friend and the debt must be paid off before you have real FCF. I am rethinking my LNET purchase, though now its quite a decent deal at 1x FCF.

 

LNET is nice because its not exactly dying like the others, and they have a fairly successful business model. USMO seems like a better deal due to low / no debt (I think they paid it all off).

[hyten1]

i person have invested in these type of business i.e. USMO, UNTD, ELNK etc

 

i typically stay away from company with a lot of debt in this type of situations, time is not their friend so debt can kill them

[beerbaron]

A huge part of the directory companies is usually Goodwill, so there is no liquidating value there. As stated previously the shareholder will not be able to get any returns until the debts are repaid. If the directory companies had a lot of TBV it would be a completely opposite story.

 

Also, can directory companies really cut down their costs in proportion to their decreasing revenues for the next 5-10 years? It all depends on how much workforce is used for the operations. What's fixed and what's variable?

 

Radio companies were stated in other posts as well, I liked the valuations but did not like the amount of leverage/time it would take me to get 100% of the FCF...

 

BeerBaron

[Guest Bronco]

Not to be critical, b/c there are many ways to make money, but I prefer looking for great businesses/great industries.  I view some of the other posts as more cigar butts - perfectly fine if you have the time and intelligence...seems like I lack both more often than not.

 

Great businesses (past, present or future) include Iphones, search by Google, money management, insurance with good investors at the helm, soda, beer, pipelines ... many, many others.  

 

Pharma used to be good.  No longer IMO.  

 

Stocks outside of these industries that look good to me right now include GPC and ITT.   Stocks I own and plan to own for a long time are the Berky B's, Loews, Pepsi, Kraft, MO MO, BAM BAM, BBEP, AHL (calls and preferreds), Mr. Prem Watsa's wealth creation machine, and a little AT&T and P&G (although not my fav right now).  I will look to JNJ at $55.

 

Sold puts (2012 Leapers) on some of the following - Visa, Sears Holding, Apple, Pfizer, Macy's, Walmart.  All are pretty out of the money, except for my friend Mr. Lampert.  I f'ing hate the stores but I cannot completely separate myself from das wunderkid (Eddie).  

 

Also nibbling on some TEF in here.  And bought some (B)igtime (H)oldings for a trade...getting too cheap for me, even with Smooth Criminal leading the charge.

 

And there is my full hand, with nothing up the sleaves.  

[Carvel46]

Myth465: How do you get to 1x FCF on LNET? On a quick glance, shouldn't you include the debt in there? EV is what matters, not MV.

[Myth465]

Myth465: How do you get to 1x FCF on LNET? On a quick glance, shouldn't you include the debt in there? EV is what matters, not MV.

 

Good point. I look at them separately.

 

I adjust the multiple I am willing to pay for leveraged investments, I look at EV but dont consider debt equity.

 

So for a leveraged stock I may pay 5x FCF, vs 10 - 12x FCF for a stock which has a small amount of debt.

[yseric]

i used to work in China's MMOG industry.  Perfect World and Shanda are reputable companies.  I won't say there is not fraud involved, because nothing is for certain. 

 

The question with MMOG companies is how you value them... can you confidently forecast their future cash flows?? hummmm,,, games are having shorter and shorter life cycle these days in China..

 

 

Cheers,

[valuecfa]

I have been bottom fishing and have found 2 industries that appear to be hated with stocks selling @ low FCF ratios.  I would like to hear others takes in these segments as my industry insight is limited in for these industries.  The first is the US directory business.  There are 3 firms who compete in this space (Supermedia, DexOne and Yell) with 2 who have recently exited from bankruptcy (Supermedia and DexOne and FFH holding a sizable position in one (SuperMedia).   Supermedia is selling for less than 1x FCF and has had rising FCF over the past few years (2008 to TTM).  DexOne is selling for slightly above 1x FCF.  Both these firms are in declining indusrtries and have debt loads @ about 3 to 3.5x EBITDA.  Paulson also owns large stakes in these.  European comps (Yell and SEAT) have debt/EBITDAs of about 5x and trad for 1.5 to 2.0x FCF.  PagesJaunes in Froance has about 3.9x EBITDA in debt and trades a 9.0x FCF.  Has anyone been looking at these?

 

 

Packer16, since Supermedia recently emerged via chapter 11, they adopted fresh start accounting, which makes year over year comparisons irrelevant, and complicating the accounting a bit over the near term.

[Packer16]

Thanks for all of your comments/input.  I asked Francis at the Fairfax shareholders dinner the question of how you value a declining firms such as Sprint at the time or Supermedia and DexOne today.  His response was to project the liquidation value 12 to 24 months from now and buy at a discount from that price.  For these two, it would 5 to 6 years to pay down the debt at current FCF levels.  This is about the same period as SGA and LNET but both of these firms are not in declining industries.  It looks like there is a good amount of uncertainty to estimate the liquidation value in 12 ro 24 months so I may put these in the too hard pile.

 

The Chinese MMOG industry sounds like it has more opportunity but I still need to get more comfortable with investing in China.   

 

Packer

[twacowfca]

Thanks for all of your comments/input.  I asked Francis at the Fairfax shareholders dinner the question of how you value a declining firms such as Sprint at the time or Supermedia and DexOne today.  His response was to project the liquidation value 12 to 24 months from now and buy at a discount from that price.  For these two, it would 5 to 6 years to pay down the debt at current FCF levels.  This is about the same period as SGA and LNET but both of these firms are not in declining industries.  It looks like there is a good amount of uncertainty to estimate the liquidation value in 12 ro 24 months so I may put these in the too hard pile.

 

The Chinese MMOG industry sounds like it has more opportunity but I still need to get more comfortable with investing in China.   

 

Packer

 

 

Declining businesses are not often managed with the main object of maximizing liquidation value.  Often, the unstated object is to preserve jobs, especially the bosses' jobs,  treat exiting employees fairly, strengthen the pension plan and other retirement benefits and keep the status quo ante as much as possible.  It takes an owner's orientation and a lot of hard work to counteract the institutional imperative to some degree in these problematic businesses. 

 

 

[Packer16]

Another way to look at these two is based upon probabilty of default of debt.  If Supermedia does not default and pays down its debt, its value is close to 40 (2.5x 5-yr FCF (assuming 10% decline in FCF per year)) or 52 (2.5x assuming a 5% decline in FCF).  The current price of USMO is 2.1 & ELNK is 3.3x with net cash a 4% (USMO) and 13% (ELNK) decline in FCF.  The current price places a 60% probabilty of default and Morningstar estimates a 20% probability of default.  twacowfca you bring up a good point, so I will check out the proxy and insider ownership to see if the incentizes are alligned to facilitate a declining industry (like USMO & ELNK are) and see what happens to the prices of these 2 stocks.

 

 

Packer 

[Uccmal]

Bronco mentioned JNJ above.  This news is interesting here:

 

http://www.bloomberg.com/news/2010-08-12/johnson-johnson-sells-1-1-billion-of-debt-at-the-lowest-rates-on-record.html

 

The gist is that JNJ has sold ten year bonds with an interest rate of 2.95% and YTM of 3.15%, and 30 years for 4.5%.

 

1 billion worth which is about 15% of JNJs total debt load.  Their dividend at the present market rate is 3.4%. 

 

Getting money so cheap certainly bodes well for future of this one company. 

 

I have shifted my focus in this climate to stocks that are paying reasonable dividends that are not in much danger of being cut.  Should there be a multiyear sideways market I much prefer to get paid along the way.