Sold Town Sports (CLUB); Bought Babcock & Wilcox (BWC)

Today, I sold my shares of Town Sports (CLUB) and put the proceeds of that sale – plus some other cash – into buying Babcock & Wilcox (BWC).

My average cost in Town Sports was $8.84 a share. My average sale price was $6.85. This is a realized loss of 23% over an 11 month holding period.

My average cost in Babcock & Wilcox is $27.06 a share. Babcock now represents 18% of my portfolio. The company will split into two separate stocks later this year. I will hold on to both of those stocks.

I may increase my position in Babcock to about 25% of my portfolio. This depends on whether: 1) I am successful in selling the last of my Japanese net-nets 2) Babcock’s share price does not rise too much.

The four non-Japanese net-nets in my portfolio right now are:

1. George Risk
2. Ark Restaurants
3. Weight Watchers
4. Babcock & Wilcox

These four stocks account for more than 90% of my portfolio.

Toby handles the Singular Diligence model portfolio. This sale has no impact on the model portfolio. Quan also owns Town Sports in his portfolio. Quan did not sell Town Sports and buy Babcock & Wilcox today. If and when Quan makes a change to his portfolio it will be posted here.

The timing of my sale of Town Sports and purchase of Babcock has to do with Babcock – not with Town Sports. Town Sports is the target of an activist campaign. Activist investors control about a quarter of the company’s shares. The board recently adopted a “poison pill” defense and the activists nominated their ticket for this year’s board election. None of these events make it a particularly good time to sell Town Sports. However, we just put out the Babcock & Wilcox issue of Singular Diligence. The publication of that issue freed me up to buy the stock. Quan and I start research on a stock far in advance of the date when that stock appears in Singular Diligence. So, I have been waiting for months to buy Babcock & Wilcox.

It is worth mentioning that I did not – and would not – have sold Town Sports merely to hold cash. I sold Town Sports to buy Babcock. This tells you 3 things:

1. I prefer Babcock over Town Sports
2. I believed Babcock was the strongest stock I did not already own
3. I believed Town Sports was the weakest stock I did own

For example, my sale of Town Sports obviously tells you that I think Weight Watchers is – at today’s price – a stronger stock than Town Sports. Otherwise, I would have sold Weight Watchers instead of Town Sports.

If you subscribe to Singular Diligence you can now read the full issues on both Town Sports and Babcock & Wilcox.…

Singular Diligence: 8 Archived Issues

These are the 8 archived issues – each is over 12,000 words long – you get immediate access to the moment you subscribe to Singular Diligence.

Singular Diligence – Archived Issues

Life Time Fitness (LTM): Runs 112 (mostly) huge gyms across 25 U.S. states. About half (55) of these clubs are on unmortgaged company owned land. Since our report was published, Life Time Fitness announced it may convert to a REIT.

Progressive (PGR): A U.S. auto insurer that competes with GEICO online. Also the largest auto insurer in the independent agent channel.

Ark Restaurants (ARKR): Runs a small number of huge restaurants in landmark locations like: Union Station, Bryant Park, Faneuil Hall, casinos, and hotels. Also has an interest in the Meadowlands racetrack in Northern New Jersey as well as the food and beverage concession there.

Town Sports (CLUB): Runs urban gyms in New York City, Washington D.C., Boston, and Philadelphia under the “Sports Club” name.

HomeServe (London – HSV): A U.K. company that provides home emergency repair services using an insurer’s premium based model. Now also in countries like France and the United States.

John Wiley (JW.A): A publisher of books, textbooks, and academic journals. The vast majority of the company’s value is in its academic journals. The Wiley family has controlled the company for 207 years.

Village Supermarket (VLGEA): The second largest operator of “Shop-Rite” supermarkets. Stores are mostly in densely populated Northern New Jersey. Each store does about $1 million a week in sales

Weight Watchers: (WTW): The world’s biggest weight loss brand. Weight Watchers runs group support meetings, the WeightWatchers.com self-help website, sells Weight Watchers products, and licenses the Weight Watchers name.…

Babcock & Wilcox (BWC): Considering Separation into Two Companies

Babcock & Wilcox (BWC) just announced it is considering separating into two companies:

“…Board of Directors is evaluating the separation of the Company’s Power Generation Business and Government & Nuclear Operations Business into two publicly traded companies. The Board’s goal is to determine whether a separation creates the opportunity for enhanced shareholder value and business focus. B&W has retained JPMorgan as its financial advisor and Wachtell, Lipton, Rosen & Katz and Jones Day as legal advisors to assist in this process.”

The company reports its results in 4 segments (one of which is the experimental money losing mPower – tiny nuclear generator – business). So it is easy to analyze what the company will look like post any possible break-up. The stock is up 7% as I write this.

It still looks cheap.…

Adidas Announces Share Buyback

Adidas announced plans to spend up to 1.5 billion Euros over 3 years buying back its own stock. The company will take on debt (it has no net debt) and continue to pay a dividend. Dealbook quotes the company’s CFO as saying:

“We believe that our shares are currently significantly undervalued and this provides an excellent opportunity to optimize the company’s cost of capital, deploy cash and create further value for our shareholders”

(Dealbook)

At the current share price, the company could buy up to 10% of its own shares over 3 years. Bloomberg also has an article on the buyback and it focuses more on the possibility of activist investors targeting the company. The article speculates activists would want the company to replace its CEO and spin-off Reebok and TaylorMade.

Adidas is very cheap compared to its two best known – and expensive – peers: Nike (NKE) and UnderArmour (UA).

Adidas is valued more in line with the company with which it shares a founding family: Puma.

When looking at the history of those 4 companies and their cultures – it is difficult to argue that Adidas is truly comparable to either Nike or Under Armour.

Regardless, Adidas is cheap given the level of stock prices generally and the multiples at which athletic apparel companies normally trade.…

Hollywood Reporter: Softbank Offers to Acquire DreamWorks Animation (DWA) for $32 a Share

The Hollywood Reporter says the Japanese conglomerate Softbank has made a $32 a share offer to acquire DreamWorks Animation (DWA).

The Hollywood Reporter followed up with some more analysis in a later article.

You can read Bloomberg’s article here.…

Barnes & Noble (BKS) Will Separate Retail from Nook

Barnes & Noble (BKS) announced it plans to break up the company:

With the objective of optimizing shareholder value, the Company’s Board of Directors has authorized management of the Company to take steps to separate the Barnes & Noble Retail and NOOK Media businesses into two separate public companies.  The Company’s objective is to take the steps necessary to complete the separation by the end of the first quarter of next calendar year.

The company provided a PDF giving segment performance.

Over the last year, Retail had positive EBITDA of $354 million. College had positive EBITDA of $115 million. Nook had negative EBITDA of $217 million.

The company ex-Nook would have $6.04 billion in sales, $1.78 billion in gross profit (29% gross margin), and $469 million in EBITDA (8% EBITDA margin).

(I do not own any shares of Barnes & Noble. I bought shares in August 2010 and sold them in December 2010).…

Stock Price Guidelines

A recent blog post at The Brooklyn Investor discusses whether Warren Buffett pays 10x pre-tax earnings for both private companies and public stocks:

It’s amazing how so many of the deals cluster around the 10x pretax earnings ratio despite these businesses being in different industries with different capital expenditure needs and things like that. Even the BNI acquisition, which many thought was overpriced (crazy / insane deal! Buffett has lost his marbles!) looks normal by this measure; a price that Buffett has always been paying. And yes, right now I’m the guy swinging around a hammer (seeing only nails), but I notice a pattern and think it’s really interesting.

(The Brooklyn Investor)

I’m often asked what’s a fair price to pay for a good business? This is a tough question, because people seem to mean different things when they say “fair price” and different things when they say “good business”.

I will suggest one awfully automatic approach to deciding what stocks are acceptable candidates for long-term investment. The simplest approach I can suggest requires 2 criteria be met. To qualify as a “good business” the stock must:

1. Have no operating losses in the last 10 years
2. Be in an industry to the left of “Transportation” in this graph of CFROI Persistence by Industry

In other words, we are defining a good business as a stock in a “defensive” industry with at least 10 straight years of profits.

If those two business quality criteria are met, what is a fair price to pay for the stock? I suggest three yardsticks:

1. Market Cap to Free Cash Flow: 15x
2. Enterprise Value to Owner Earnings: 10x
3. Enterprise Value to EBITDA: 8x

These are “fair” prices. A value investor likes to pay an unfair price. So, these are upper limits. They are prohibitions on ever paying more than 15 times free cash flow, 10 times owner earnings, or 8 times EBITDA.

At Berkshire, Buffett is willing to pay a fair price – 10 times pre-tax earnings – for 2 reasons:

1. Berkshire amplifies its returns with leverage (“float”)
2. Buffett has learned to find a margin of safety in places other than price

For example, Buffett talks about Coca-Cola (KO) as if the margin of safety was the profitable future growth of the company. He was paying a fair absolute price (it was a high price relative to other stocks at the time), because he knew it was a good price relative to earnings a few years out.

Let’s take a look at the 5 guidelines I laid out:

1. Have no operating losses in the last 10 years
2. Be in an industry to the left of “Transportation” in this graph of CFROI Persistence by Industry
3. Market Cap to Free Cash Flow: 15x
4. Enterprise Value to Pre-Tax Owner Earnings: 10x
5. Enterprise Value to EBITDA: 8x

Implementation of this – or any – checklist approach requires one additional thing: common sense.

Common sense often finds itself at odds with two other types of sense:

1. Theoretical Sense
2. Technical

IMS Health (IMS): 4 Years Later

I bought shares of IMS Health (IMS) in early 2009. The company went private in 2010. That buyout (involuntarily) ended my investment in the stock. Now in 2014, IMS Health is going public again. I don’t invest in IPOs. So, I’m not interested in the stock. But, I am interested in what has happened with the company. Some things have changed. Others have not.

Here is the S-1.

While under TPG’s control, IMS Health bought a lot of stuff. In 3 years (2011 through 2013), IMS Health spent $900 million on 22 acquisitions, “internal development programs”, and “capital expenditures”.

I’m not sure if they are including “additions to computer software” in that number. I treat it as a capital expenditure when analyzing IMS Health (or any database company) but it is reported on a separate line of the cash flow statement. Additions to computer software is always a bigger number for IMS Health than other capital expenditures. Over the last 3 years, software capital spending has averaged $73 million a year while other capital expenditures have been just $38 million a year. You will notice that capital spending (which we just said was $111 million a year plus acquisitions) and depreciation are totally unrelated. This is a good place to mention that GAAP numbers are irrelevant at IMS Health. You always want to focus on your expectations of normal future free cash flow. The business is very stable, so there’s little need to “normalize” anything on the customer side.

This quote from the S-1 sums up what interested me in the stock originally:

The average length of our relationships with our top 25 clients, as measured by 2013 revenue, is over 25 years and our retention rate for our top 1,000 clients from 2012 to 2013 was approximately 99%.

This is IMS Health’s moat. It is the one thing about the company you want never to change if you’re going to hold the stock for the long-term.

The new owners churned through the workforce astoundingly fast:

Since the Merger…we added approximately 7,600 employees…and oversaw the departure of approximately 5,200 employees…We estimate that about 60% of our approximately 9,500 employees have joined us since the Merger…

So, IMS Health – a 60-year old company with an average customer relationship of 25 years – is now mostly made up of employees who have been with the company for less than 3 years.

I can’t recommend looking at IMS Health as a possible investment. However, I do recommend reading the S-1. It offers some insight into both a company with a competitive position I really like and what a private equity owner does to a once and future public company.

Talk to Geoff about IMS Health (IMS)…

G Asset Management Makes 2 Offers for Part of Barnes & Noble (BKS)

G Asset Management put out a press release announcing 2 different offers for different parts of Barnes & Noble (BKS):

 …a proposal to acquire 51% of Barnes & Noble, Inc., valuing the company at $22 per share, a ~30% premium to the current market price.

Alternatively, GAM has proposed to acquire 51% of the Nook segment, valuing the segment at $5 per share. GAM  stated in its proposal that it was extremely confident that if the Nook segment is separated from the profitable retail and college business, substantial shareholder value would be created.

(Press Release)

Talk to Geoff about Barnes & Noble (BKS)…

Moody’s Downgrades Weight Watchers (WTW) Debt to B1 With Negative Outlook

Moody’s downgraded Weight Watchers (WTW) debt:

Moody’s expects a sharp drop in 2014 revenue and EBITDA to about $1.4 billion and $325 million, respectively, even with management plans to initiate cost reduction programs. As a result, debt to EBITDA (after Moody’s standard adjustments) may increase to above 7 times, which is high for the B1 CFR. Moody’s anticipates Weight Watchers will remain profitable but down considerably from earlier expectations and generate at least $100 million of free cash flow. Lowered free cash flow and in Moody’s view financial covenant constraints will limit Weight Watchers access to about $50 million of its revolver, so the Speculative Grade Liquidity rating was revised to SGL-3. Liquidity is considered adequate.

The negative ratings outlook reflects Moody’s concern that evidence of business stabilization may not appear in 2014, which could imply further deterioration of financial leverage and cash flow.

(Moody’s Downgrade)

The “Debt” section of our notes always assumed Weight Watchers would only have access to $50 million of revolving credit. Interest costs increase 0.25% ($6 million a year) when rated below Ba3 by Moody’s (B1 is lower) and Standard & Poor’s. See the debt section of our notes for details.

Separately, Morningstar downgraded the “moat rating” for Weight Watchers from “wide” to “narrow”. You can find our discussion of free apps (the reason for Morningstar’s downgrade) near the end of the notes PDF.

I promised I would tell you if Quan or I changed our position in Weight Watchers. Today, Quan added to his position.

Talk to Geoff about Weight Watchers (WTW)…