Friday, March 13, 2009

Mark Sellers' first conference call as Premier's Chairman

Now that I am sufficiently recovered (I think) from listening in on Mark Sellers' first conference call as Chairman of Premier, here's the link to the transcript of the same.

Things are in much worse shape at Premier than I'd envisioned (I was pessimistic before the call). As I'd posted elsewhere, I was certainly wrong in my assessment that prior management was running the company terribly. The truth is that that they were hardly running the company at all. I still cannot believe some of the stuff that Sellers mentioned in that call. I'll bet Sellers wasn't prepared for most of it either. The single most damaging piece of information to come out of that call was the lack of scheduled exhibition days for later this year. This implies that capital will need to be raised (although there was no indication of just how much would need to be raised) with the options ranked in the following order:
(a). Selling a portion of the business. I'd guess Sellers was referring to the Titanic (and it's associated assets) here.
(b). Raising debt capital.
(c). Raising equity capital. The question here is the amount of dilution that might occur under this scenario.

If none of this works out, Sellers mentioned that they'd look to sell the entire company. Clearly, though, this is his least preferred option. The interim CEO, Chris Davino, spoke for a bit about the problems at Premier and how they were approaching it. I liked the guy. He was brutally honest and realistic about the situation. As would be obvious in a situation like this, they are looking to get to cash-flow neutral as a first step. I find it interesting though that Chris has been appointed for a period to last between 4-6 months. That, quite possibly, gives us an upper bound on management's estimate for Premier to get back to at least not bleeding cash.

On the good news front(there is some), Sellers was quite clear that Premier wouldn't provide earnings guidance any more. If every CEO in the corporate world were to make the same decision, long-term shareholders, in aggregate, would be wealthier than they would be otherwise. This decision alone is indicative of Sellers' clear understanding of the true nature of most businesses(even if their managements would like you to believe otherwise) and his gumption in standing up for what he believes in. In this otherwise sordid affair to date, I couldn't be happier than to be associated with a manager like Mark Sellers.

The company has some serious issues to work through. Quite clearly, I made a mistake in making the decision to buy Premier. There was at least one issue that, if I'd picked up on it, would've given me serious qualms about buying into Premier. I'll have more to say about that in another post. The outcome of the investment may still be alright from here, but that'll have been despite my process, not because of it.

Often wrong but seldom in doubt,

Tuesday, March 10, 2009

Examining Steak 'N Shake's debt covenants

There have been some suggestions that Steak ‘N Shake is likely to be in violation of it's debt covenants that were amended in November 2008. The amendments were brought on by the violation of the original debt covenants that were in place as prior management essentially ran the place down. I was initially drawn to Steak 'N Shake in early 2008 for the following reasons: The owned real estate, carried on the books at historical cost, that would likely provide protection against a permanent loss of capital, the healthy cash flows from an established restaurant brand in the relatively recent past and, last but not the least, Sardar asking for board seats for himself and Phil to help fix the terrible capital allocation policies and operational inefficiencies. In the midst of all this, I neglected to look at the debt covenants that SNS was then pushing up against. Since I am not particularly keen on making the same mistake again(in the same security, no less), we'll take a look at how things stand today as far as the revised covenants go.

There are 2 covenants that need to be met, one relating to the balance sheet and one related to the debt servicing ability of the company’s business operations.

The debt covenants related to SNS’ line of credit issuer, Fifth Third Bank, is

Here’s how the ratios relating to the covenants for Fifth Third look as of Dec 17, 2008:
Ratio Actual Required
Total liabilities/ Total Tangible Net Worth .89 <= (1-1.1)
Fixed charge coverage ratio 1.25(1)(2) >=(.7-1)

The debt covenants related to SNS’ Senior Notes issuer, Prudential, is

Here’s how the ratios relating to the covenants for Prudential look as of Dec 17, 2008:
Ratio Actual Required
Total liabilities/ Total Tangible Net Worth .89 <= (1-1.1)
Fixed charge coverage ratio 1.84(1)(3) >=(.7-1)

The required ratios for the fixed coverage ratio increase every quarter ending with a required range of not less than between (1-1.2) for the last quarter of fiscal 2009. The examination of this ratio changes into a rolling 4-quarter test
after the end of the last quarter of fiscal 2009, which effectively means that the clock has started ticking beginning the first quarter of fiscal 2009, the numbers for which can be seen above.

Overall, the numbers look ok for now, with trouble not looking imminent in the near term. Especially so when you consider that the 1st and 4th quarters are traditionally the slowest for Steak ‘N Shake. I’d expect to see the debt paid down by the asset sales (the long-term debt of about $11.5 million costs an exorbitant 9%), so this should be less relevant going forward.

Often wrong but seldom in doubt,

Notes to calculations:

1. The numerator in the fixed charge coverage ratio calculation works out to $12,136,000.
2. The denominator in the fixed charge coverage ratio calculation works out to $9,684,000.
3. The denominator in the fixed charge coverage ratio calculation works out to $6,602,000.

Friday, March 6, 2009

Brief thoughts on Buffett's letter to shareholders

Well, really brief actually: Buy Berkshire.

What were you expecting? I've only read it the 3 times so far. A's going for $72,400/share at this time.

Often wrong but seldom in doubt,

Wednesday, March 4, 2009

A look at Western's purchase of Mustang Capital

Western agreed to purchase a 51% interest in Mustang Capital Advisors in the first quarter of 2008. Here are the numbers for Mustang from 2006 through 2008. All amounts are in dollars.

Year 2008(9 months)2007 2006
Operating income (Management fee income less operating expenses) 282,524 (376,698 annualized) 234,070 148,346
Net portfolio income - 3,006,532 1,541,847
Portfolio income, net of minority interests - 613,063 374,591
Assets in portfolio @ end of year - 13,629,075 10,824,470
Minority interest in assets - 12,672,954 10,279,485

Source for numbers above and calculations below:
There are 2 sources of income for Mustang:
a. The management fee income that accrues from providing investment advice to third parties.
b. The performance incentive (20% allocation) for beating a hurdle rate of 4% on the actively managed funds, the size of which is reflected by the row titled ‘Minority interest in assets’ in the table above. The estimated returns for 2006 and 2007(assuming no deposits/withdrawals during the year) look pretty good at 16.6% and 27.78%. 2008 has been difficult, with the equity portfolio down $347,132 on a cost basis of $6,348,528 as of Sept 30, 2008. I'd expect that the decline has continued through the rest of the year.

The segment that provides the management fee income has been growing nicely, as can be seen from the numbers above. The portfolio income, dependent as it is on market values for the securities held, is a little harder to evaluate. Let’s assume that John Linnartz, the fund manager at Mustang, and the managers that will succeed him, are able to invest the assets at 6% in perpetuity. We’ll also make the assumption that the capital invested in the funds remains the same i.e. all returns are distributed to the investors in the funds. The portfolio income is therefore 20% of the excess spread (6%-4% = 2%) on a capital of approximately $12.6 million (the incentive allocation is only on the minority interest in the funds). This works out to $50,400 annually. The value of this income stream in perpetuity, discounted at an opportunity cost of 15%, is $336,000.

There is also about $1 million in capital in the funds that belongs to the general/limited partners in the funds (essentially John). Let’s say that this was worth “book” value at the end of 2007 i.e. 1 million.

So, at the end of 2007:
Mustang’s value = Book value of capital of general/limited partners + Value of the actively managed funds + Value of the management fee income stream
= $ 1 million + $336,000 + Value of the management fee income stream

Western’s purchase price, for a 51% interest in Mustang = $ 1.173 million ($300, 000 in cash + rest in Western stock)
Implied value of Mustang based on Western’s purchase price = $2.3 million

Value of the management fee income stream (inferred from value of Mustang above) = $2.3 million - $1.336 million = .96 million
Implied multiple on 2006 operating earnings (lowest of the 3 years) = 6.5
Implied multiple on estimated 2008 operating earnings (highest of the 3 years) = 3.4

For a business with little on-going capital expenditure requirements, these are great multiples on what can reasonably be expected to be recurrent earnings, if you are the buyer. When you factor in the conservativeness of the assumptions (6% returns on managed funds, payout of all returns), this seems like a steal for Western. A few possibilities that lend themselves as possible explanations are:
1. I am missing something in my valuation (always possible).
2. The assumptions underlying the valuation of the managed funds are not as conservative as I think they are.
3. John’s estimate of the value of Western’s stock was higher than it was trading for at the time of purchase ($16/share). In fact, I’d go as far as to speculate that without Western’s stock comprising a majority of the purchase price that this deal wouldn’t have gone through for the price that it apparently did.

Often wrong but seldom in doubt,