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.
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).
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.
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:
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:
Market Cap to Free Cash Flow: 15x
Enterprise Value to Owner Earnings: 10x
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:
Berkshire amplifies its returns with leverage (“float”)
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.
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.
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.
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.
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.
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.
Today, I bought Towns Sports International (CLUB). My average cost was $8.77 a share. I put 19% of my portfolio in the stock. This is my first stock purchase since Weight Watchers (WTW) in August 2013. I am now 100% invested in stocks.
A lot of people emailed me about Weight Watchers (WTW) after the company reported earnings and the stock dropped about 25% last week. Some of the people asking about Weight Watchers were subscribers to The Avid Hog. Others were not. For the first few issues of The Avid Hog (including the issue in which we picked Weight Watchers) we did not put out a “Notes” PDF with the issue.
Since a lot of people said they were “rethinking the thesis” or “considering selling” or “thinking about doubling down” on Weight Watchers at today’s price, I thought we should post some items with information that might be useful.
Weight Watchers is down 49% from where Quan bought it, 44% from where I bought it, and 35% from where we picked it for The Avid Hog. Quan and I still own the stock. We have no plans to sell it. We’ll let you know if that changes.
The notes have been updated to reflect the most recent (much lower) stock price and to discuss the 3 topics most often asked about in emails: 1) Debt 2) Free Apps 3) Artal.
If you want to know our thoughts on the company, please read the “Notes” above. They capture our thinking better than I could in a blog post. For information about Weight Watchers’s debt please read the “Debt” page of the notes. You should also read the actual 8-K explaining the credit agreement. For management’s thoughts on the company and the “turnaround plan” please read the Investor Day Presentation and either listen to the last 2 earnings calls or read the transcripts. You can find them on the company’s website, at earningscast.com, at Seeking Alpha, etc.
Like I said, if Quan or I change our positions in Weight Watchers in any way – we will update you the moment we do so.
The following stock may appear in a future issue of The Avid Hog.
Catering International & Services trades in Paris under the ticker “CTRG”. The company was founded in Marseilles, France in 1992. Two families control 71% of the shares. The founder, Regis Arnoux, controls the majority of the company’s shares. He still runs the company. Catering International provides remote site services (mainly catering) in extreme conditions. Revenue is about evenly divided between serving mining customers (51%) and oil & gas customers (47%). Operating profit – but not revenue (more on that later) – is about evenly divided between Asia/Pacific (54%) and Africa (46%). So, we’re basically talking about a company that caters for mines and oil fields in Asia and Africa.
Let’s start with how I found the company.
I ran a screen at Stockopedia looking for E.U. stocks sorted by their gross profits relative to net tangible assets. I then eliminated companies that either had lost money in one of the last few years or that now traded above 8 times EBITDA. I also eliminated companies where the business description suggested they were far from all 3 rings of my circle of competence: 1) consumer habits, 2) business support services, and 3) industry standards. This left a little over 40 stocks. I then looked for English language information on all 40 stocks. About 14 of these stocks had multiple annual reports in English. Catering International was one of them.
A few things appealed to me immediately about Catering International. The business sounded both mundane (catering) and niche (extreme conditions). It’s a business support services provider. Gross profitability was adequate.
A few things also concerned me right away. Catering International serves mining and oil & gas customers. That means the commodities these companies are extracting – their reasons for being at these sites – are at bubble levels. I’m not saying they are in a bubble. The supply of oil and gas is finite. So you can argue that bubble prices relative to the past could be justified throughout the future. But there is no long-term history of prices being this high. Therefore, we don’t have a relevant record of consumer or producer behavior to go on. We don’t know how marginal – high cost and high risk – some of these sites are. Catering International has been a very fast growing company. Some of that growth was driven by customer interest in more extreme conditions which high prices for commodities like oil and gold have to encourage.
The good news is that you don’t have to expect a lot of future growth to invest in Catering International. Using the most aggressive estimates of EBIT and enterprise value you get a price of 6.5 times EBIT for the company. Using the most conservative estimates of EV and EBIT you get a ratio of 8.2 times. Any price less than 10 times EBIT seems quite fair for a company like this – even without a lot of growth.
Companies such as Coca-Cola and Gillette might well be labeled “The Inevitables.” Forecasters may differ a bit in their predictions of exactly how much soft drink or shaving-equipment business these companies will be doing in ten or twenty years…however, no sensible observer – not even these companies’ most vigorous competitors, assuming they are assessing the matter honestly – questions that Coke and Gillette will dominate their fields worldwide for an investment lifetime.
I happen to have a Standard & Poor’s Stock Market Encyclopedia published in 1967. So, I figured I could check just how persistent the profitability of these “inevitables” is.
Here are the operating margins of 5 such inevitables.
There’s a new value investing blog called “Moatology”. This post on Pulse Seismic is a good example of what the blog does best. Moatology brings you good businesses you haven’t heard of. If you’re looking for a value investing blog to add to your reading list, check out Moatology.…
