Luby’s (LUB): Luby’s is Liquidating – What’s the CAGR Math Behind Possible Payouts and Timing?
This is a simple situation. But, you’ll want some background info before reading my take on it.
Information you might find useful about this one can be found at:
And my comments in this podcast (starts at 31 minutes)
The stock is Luby’s (LUB). It is liquidating. The company estimates it could make liquidating distributions of between $3 to $4 a share. It doesn’t set a timetable for the distributions. However, elsewhere in the proxy statement a period of 1-2 years is the estimate given for when they will get an order for the Delaware court that would provide them the sort of safe harbor they want to make distributions. As soon as they got that order, they might make the first of the distributions. I suspect they will make no distributions before getting the order. So, the company is saying it expects to pay out $3 to $4 per share no sooner than 1-2 years from now. The stock is at $2.58 a share.
Let’s just do the math with those numbers: $2.58 price today, $3 distribution, or $4 distribution, 1 year, or 2 years from now. I don’t necessarily believe some of these numbers. But, let’s put that aside for now, because these are the actual sort of company estimates we see in the proxy statement instead of guesses made by me or others.
Buying at $2.58 and getting paid $3 in 2 years is an 8% annual return.
Buying at $2.58 and getting paid $3 in 1 year is a 16% annual return.
Buying at $2.58 and getting paid $4 in 2 years is a 25% annual return.
Buying at $2.58 and getting paid $4 in 1 year is a 55% annual return.
So, if you really expect to be distributed $3 to $4 per share within 1-2 years, you should buy the stock. The expected return range is 8-55%. If we take the middle of both price and timeline – that is, $3.50 in 18 months – that’s a 23% annual return. Which is really good. And if you assume the downside here really is something like earning 8% a year for the next 2 years – there’s no reason to assume you can do better than that in any index, any safe form of bond, etc. Stock pickers might be able to do better than 8% a year over the next 2 years. Your opportunity cost could be a lot higher than 8%. But, the certainty might be higher here.
Also, I have not presented the real upside here. The $3 to $4 estimate presented by the company in its proxy statement is not the actual estimate of the liquidation distributions provided by the company’s financial advisors. Like most companies considering “strategic alternatives”, Luby’s formed a special committee which then hired a financial advisor. The financial advisor – Duff & Phelps – came up with an estimated range for the liquidating distributions that would be paid to shareholders.
The range was not $3 to $4 a share.
It was $4.15 to $5.62.
The special committee then took this estimate of $4.15 a share to $5.62 a share in liquidation distributions and cut it down to $2.94 to $3.75 a share which it recommended the board adopt as the number used in the proxy statement. The full board eventually chose $3 to $4. Which seems like just a rounded off figure taken from what the special committee recommended. There is no information in the proxy statement providing any support for using a $2.94 to $3.75 estimate instead of a $4.15 to $5.62 estimate. Now, COVID did happen. But, the discussions about liquidating distributions – and the efforts to sell part of the company and so on – were all ongoing through COVID. There is language in the proxy statement giving the impression the company made no attempt to re-estimate anything like liquidating distributions after COVID happened. But, discussions were held during the period when the company’s stock price had already been obliterated by COVID, the commercial real estate market for restaurant properties was in an unusual state, etc. Legally, the company will say that it did not make any attempts to update estimates for the impact of COVID, etc. But, some of the board are major shareholders. It’s also impossible to believe they did not consider COVID – they just don’t want to take responsibility for having to estimate the negative adjustment downwards to liquidating distributions caused by COVID.
Let’s update the possible liquidating distributions to reflect the biggest range possible. The minimum suggested by the special committee was $2.94. The maximum suggested by the financial advisor was $5.62 a share. So, the range of estimates is $2.94 to $5.62. The proxy statement suggests an order from the Delaware court could take 1-2 years. We’ll use that for now (though, it’s likely an underestimate – because, the company would make THE FIRST liquidating distribution shortly after getting the order instead of making ALL the liquidating distributions quickly after getting the order).
So, the worst return possible would be buying at $2.58 today and getting cashed out at $2.94 in 2 years.
That’s a 7% annual return.
The best possible return would be buying at $2.58 today and getting cashed out at $5.62 in 1 year.
That’s a 120% return.
Let’s consider what happens to this very wide range – 7% to 120% – if we adjust the timeline for distributions but keep the payments the same (a range of $2.94 to $5.62). I am assuming one lump sum liquidating payment. The reality is more likely to be two or more liquidating payments over time.
So, for buying at $2.58 today and getting cashed out at between $2.94 and $5.62 – the liquidation timeline alters the CAGR range as follows:
1 year: 14% to 118%
2 years: 7% to 48%
3 years: 4% to 30%
4 years: 3% to 21%
5 years: 3% to 17%
10 years: 1% to 8%
There are a few things to consider here. Considering this is a “workout” – as Buffett would call it – returns are borderline adequate across the entire timeline I’ve laid out. Even a 1% to 8% return over 10 years or 3% to 17% return over 5 years is not out of line with where interest rates are today. It also may not be out of line with 5-10 year returns in stock indexes. So, even if the liquidation takes a long time to happen – returns would still pay you decently for your time. It would be a mistake to invest in this if it is going to take 5-10 years. But, it wouldn’t be as costly a mistake unless the range of values – not just the range of times till liquidation – is way off what you expect.
“Way off” might be an exaggeration. By presenting these figures in per share numbers to be paid out to equity holders – I am hiding the leverage in the appraisals here. See, the company has debt. Relative to the appraised value of the properties – it is extremely small. Debt was about 20% of the property appraisal. You can check this by looking at the asset coverage ratio covenant in the loan this company has. That’s not huge. If you imagine we marked up the assets to be carried at the appraised value of the properties, the assets would be supported by about 80% equity (at excess of market value of properties over liabilities) and 20% debt. There’s also the actual assets and liabilities of the business excluding real estate. I’m not going to discuss that here. The thing to focus on is the general rule that the assets here – as appraised – are being converted into about 4 parts equity for every 1 part debt. If you halve your valuation of the assets, the debtholder still gets paid in full. The haircut – in dollar terms, not just percentage terms – is taken 100% by the proceeds you’ll get in liquidation.
Therefore, the margin of safety here is not as wide as it appears.
Let’s try to estimate what kind of length of time and what kind of reduction to the appraisal value of these assets we could really handle and still do okay in the stock.
The bottom end of the range – $3 in proceeds – offers really no protection in terms of assets being appraised lower than expected. If actual proceeds from property sales come in at like 90% of what the $3 number assumes – you’ll lose money. So, no margin there. The actual range from Duff & Phelps – $4.15 to $5.62 – does offer more of a margin of safety.
Now, let’s look at time based margin of safety.
Let’s start by assuming this liquidation will take 5 years.
I don’t think it’s a good idea to assume 3 years or less. It may very well happen within that time frame. The first liquidating distribution – which could be the biggest, who knows – should happen in 1-2 years. Maybe using a 3 year estimate is best. But, 5 years seems conservative enough. Most people will assume the liquidation will be completed within 5 years – and probably a lot sooner – so, this is a good timeframe to use.
If I use a 3-5 year estimate, the CAGR ranges I get at various price levels would be:
$2.94 (special committee minimum): 3% to 4%
$3.75 (special committee maximum): 8% to 13%
$4.15 (financial advisor minimum): 10% to 17%
$5.62 (financial advisor maximum): 17% to 30%
These ranges seem more reasonable to me. I don’t mean that in the sense the outcome is likely to fall within this range. It’s easy to imagine some of the liquidating distributions coming much sooner. But, if we are trying to think of a range of years from now during which more than 50% of the eventual liquidating payments would’ve already been made – something like 1.5 to 2.5 years seems reasonable. That’s not that far different – half of distributions made in 1.5 to 2.5 years – from assuming ALL distributions are made as a single lump sum at the end of 3 to 5 years. It’s more conservative (and simpler) to assume it the way I did.
So, what we’re saying here is we expect more than half of liquidating distributions in the $2.94 to $5.62 a share range to have been made by early 2022 to early 2023.
Given today’s stock price, returns are really only acceptable if the $3.75 maximum suggested figure from the special committee is the number taken. We need a minimum payout here of like $3.75. And that’s only for an adequate return. And probably not a very good “risk-adjusted” return when we consider the chance you could lose money on this thing.
The range that’s genuinely interesting as a workout is the $4.15 to $5.62 range.
Here’s why. Warren Buffett suggested that his unleveraged returns in workouts, arbitrage, etc. were in the 20% a year type range. These are unleveraged returns. He liked to leverage them up by paying for only 50% of his purchase of the stock in cash. The other 50% was margin debt.
The $4.15 to $5.62 range – when compared to today’s $2.58 share price – hits this 20% type return target over the following timeframes.
$4.15: 2.5 years
$5.62: 4.5 years
Again, we can – somewhat conservatively – compare these lump sum timelines with “time-till-half” timelines. So, 15 months to 27 months.
Is it reasonable to expect that distributions here will be $4.15 to $5.62 a share – the financial advisor thought so – and at least half completed by 15-27 months from now (start of 2022 till start of 2023)?
Maybe.
If so, it’s a Buffett style workout. And he’d leverage this thing up by using half debt to fund it.
The liquidation here might be uncorrelated with the market. I think it should be. But, it may not be uncorrelated with the economy.
The thing that worries me here is that corporation has little cash, it has no access to credit, it is burning cash, and the value of the assets could decrease over time.
So, I’m not worried about the timeline bringing down the CAGR. I’m worried that the longer the liquidation takes the lower the net proceeds paid out to shareholders will be.
I didn’t discuss what is being liquidated here. The company operates cafeterias under the Luby’s name – primarily in Texas – and Fuddrucker’s (both company owned and franchised) around the country. There may be value in the Fuddrucker’s name and franchise agreements. The only value in Luby’s is the real estate. They are large format locations with plenty of parking and visibility and so on located around major Texan cities.
Andrew and I live in Texas. We could easily visit all the Luby locations in and around Houston, Austin, San Antonio, and Dallas-Fort Worth – as well as many of the Texas locations sited outside any real metro area. I estimate most of the relevant value in determining what liquidating proceeds will be in this case comes down to just Luby’s and Luby’s/Fuddrucker combo locations in Texas. That’s it. If you visit every Luby’s location in Texas – you have seen first hand nearly all the assets you need to evaluate to appraise the liquidation value here.
Making such visits would be the logical next step.
Geoff’s Initial Interest: 50%
Geoff’s Re-visit Price: $2.25/share