Penn Up 30% On Spin-off Announcement.

Penn National Gaming LogoPenn National Gaming (PENN), the North American casino and racetrack operator, is up almost 30% or over $11 to $48.76 this afternoon after it announced to separate into two companies with a tax free spin-off. 

One company will the REIT which will own majority of PENN’s assets and lease them to the other operating company (PNG). PENN shareholders will receive one share of the REIT and $15.40/share of taxable dividend comprised of $5.40 cash dividend and additional REIT shares. The REIT expects to pay a $2.36 annual dividend based on 2013 guidance. 

The transaction is expected to occur in Q4 of 2013 and an S1 filing has not even occurred.

Here is the investor presentation below.

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Disclosure: I do not own PENN

HypeZero10 Beats S&P By 3.2%

For those investors new to HypeZero, we run an automated portfolio of 10 of the best investment ideas from the best hedge funds called HypeZero10.

We take the quarterly holdings of the best hedge funds, and then run our sophisticated algorithm on those holdings to pick the 10 ideas.

This algorithm has returned over 170+% since 2004 exclusive of dividends. A $10,000 investment would be worth $27,000 in over 8 years.

For the August 15th to November 15th quarter, HypeZero10 was flat as compared to -3.2% for the S&P.

Here are the results:

Company Price (Aug 15) Price (Nov 15) Hedge Fund 
Apple Inc. (AAPL) $630.83 $525.62 David Einhorn
Sears Holdings Corporation (SHLD) $56.60 $58.48+spinoffs Edward Lampert
AIG (AIG) $34.03 $31.24  Bruce Berkowitz 
Yahoo! Inc. (YHOO) $14.76 $17.89  Dan Loeb
Procter & Gamble Co. (PG) $66.64  $66.32  Warren Buffett 
AutoNation Inc. (AN) $39.53 $40.28  Edward Lampert 
BankUnited, Inc. (BKU) $25.78  $22.16  Wilbur Ross
News Corp. (NWSA) $23.32 $23.12  Donald Yacktman 
Assured Guaranty Ltd. (AGO)  $13.41 $12.88  Wilbur Ross
Canadian Pacific Railway Limited (CP) $84.38 $90.38 William Ackman
Return  +0.0% S&P Return -3.2%

Check out new holdings for the November 15th quarter at HypeZero10. I will have more details, but AIG is the top pick as a number of hedge funds are bullish on the stock.

Disclosure: I am long AIG

Einsteins Worth A Look

Einstein Noah Restaurant Group Logo

Einstein Noah Restaurant Group (BAGL) owns, operates, franchises, and licenses bagel specialty restaurants under the names Einstein Bros. Bagels, Noah’s New York Bagels, and Manhattan Bagel brands. It is also a long term holding of famed investor David Einhorn. Greenlight Capital, the firm run by Einhorn, holds over 10 million shares or over 63% of the outstanding shares of BAGL. He has held this position in BAGL for over 5 years. Unlike some of his other investments, BAGL has not been a big success. So, he has been pushing management to increase shareholder value.

In May, management announced that it is exploring strategic alternatives such as a merger or a sale to increase shareholder value. The stock shot up from $14 to over $16+.

In mid October, it provided a peek at third quarter results, and updated investors on the progress of the strategic alternative initiatives  In addition to selling or merging the company, BAGL is thinking about recapitalizing the company and giving a special dividend of $154 million or $9 dividend. Third quarter results were below expectations and investors sent the stock down about 10% from $17.81 to $16.10.

The company also shared the presentation it made to public lenders to secure the recapitalization loan. See the full presentation below.

 

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Recapitalization summary

Here are the details of the recapitalization summary:

  • $265 million in senior secured credit facility.
    • $240 million of that is 1st lien term loan
      • $154 million dividend to shareholders
      • $70 million Refinance existing debt
      • $13 million Transaction expenses
      • $2 million OID
    • $25 million revolving credit facility

The company will be highly leveraged. With a $53 million adjusted EBITDA for 2012, the company will have a pro forma leverage ratio of ~4.5 ($240/$53) . As I mentioned, the dividend will be $9/share.

The transaction was supposed to be completed by November 5th. However, nothing has happened. So, there might be some issues with the recapitalization.

Why worth a look?

The stock has recently dropped from $17.81 in October 16th to $14.37 as of yesterday. It now trades at pre strategic alternatives announcement price. At this price, the company trades at a fair valuation and still has upside if the company is sold or recapitalized.

Valuation

For 2012, the company is on target to earn $.95/share or $16 million. It will have depreciation expense of around $20 million. About $10 million of capitalization expenditures is maintenance capitalization. So, BAGL has about $26 million in FCF. A rough multiple of 10 gives a market capitalization of $260 million. At $14.37, BAGL trades under a market capitalization of $250 million. It is by no means cheap, but it is not expensive here.

It also has other things going for it:

  • David Einhorn holds a majority stake. So, he is going to do everything in his power to increase value.
  • $.50 dividend or ~3.5% yield. 
  • Revenue and earnings have been steadily increasing over last couple of years.
  • Bagels are good and store concept is bright and clean.
  • Growing through not only company store expansion, but also through licensing and franchising.
  • Opportunity for growth. Only 783 restaurants nationwide.

Recapitalization Valuation

 Einstein Noah Restaurant Group Post Recapitalization Earnings

Based on my calculations, there is up to a $5 upside if the company is recapitalized. $9 divided and a $10/share post recapitalization value based on 10 times FCF of $17.5 million.

I want to get in at below $14.5 for an initial small position and add to the position if it goes below $14.

Follow me on Twitter  or like on Facebook for latest trade updates.

Disclosure: I do not own BAGL. 

Nacco, Engility, Tyco

Nacco Industries

Nacco Industries (NC) declared a special dividend today of $3.50 and extended its $50 million stock repurchase plan. The company is up $1.50 at around $55.  After the spinoff, I thought it was 20% undervalued and should trade around $53. At $55, I think it is fully valued.

Here is the press release

Engility

Engility (EG) reported third quarter results. The company raised 2012 adjusted earnings forecast and reported an increase of 5% in funded backlog ($788 million). I did not see the margin improvement that I would have like to see for me to buy the stock. Obviously, the market liked the result and stock is up over 6% to almost $20.

Read my analysis here and see the results here.

Tyco

Tyco (TYC) reported third quarter results this morning. The company beat on revenue, but missed on earnings. It also issued a lower 2013 outlook. The stock is up a little bit today. I continue to think the post spinoff Tyco is full valued and does not have much upside. It trades at 15 times 2013 earnings forecasts and does not have much top line revenue growth. Management is targeting 15% earnings growth over the next couple of years mostly through margin improvements. 

See the results here.

Disclosure: I do now own any of the stocks mentioned.

Genie Energy Third Quarter Results

Genie Energy (GNE) reported third quarter results this morning. In my analysis of Genie, I thought the stock was undervalued, but I ended up not buying any shares because I was not comfortable with the churn rate of 6.6% a month at IDT Energy.

In the current quarter, the churn rate is still 6.6% and SG&A expenses were up 46.9%. The SG&A expenses were higher because the company is spending a lot of money trying to acquire customers. The management acknowledged that “reducing churn remains a key operational objective at IDT Energy.” However, I believe churn rate will be high unless they change their business model. Currently, customers are not signed to any long term contracts and are not guaranteed to save money. 

I would continue to avoid these shares until results improve at IDT Energy. Right now, the company is a lottery ticket. If investors really want to get into the company, then maybe longer term options might be the best way to play it.

I don’t like the preferred (GNE-PA) over the long term either. They will not have any problem paying the preferred dividend because the float is so small and the balance sheet ($95.5 million in cash/no debt) is very strong. However, if Genie spends a lot of money on the shale initiatives and nothing pans out, the company could be in trouble.

Disclosure:  I do not own Genie.

Lumos Networks Spin-off

Lumos Networks LogoLumos Networks (LMOS) has not had much luck after it was spun-off NTELOS (NTLS) last year in November. The stock, at $8,66, is down almost 40% from its IPO. However, investors would be wise to take a second look at this busted spin-off.

Business

Lumos is a “fiber-based network service provider in the Mid-Atlantic region.” It has a 5,800 route-mile fiber-optic network presence. The network is not fully owned by Lumos. “83% of our approximately 5,800 route-mile network is under long term leases or Indefeasible Rights to Use, or IRU, agreements that provide us access to fiber owned by other network providers.”

The company has two sources of revenue:

  • Legacy Voice and Network Access
  • Strategic Data

Legacy Voice and Network Access

The Legacy Voice and Network Access source provides “wireline communications services to residential and enterprise customers”. Network Access charges are fees charged to other telephone companies by Lumos for the use of its local network. As you can guess, with the proliferation of cell phones and VoIP enabled services like Vonage, this source of revenue is in a free fall. To make things worse, this July, FCC reduced network access rates and has plans to entirely eliminate them over time.

This source of revenue comprised over 49.7% of total revenue in the third quarter of 2012. Of that Network Access’s revenue was 18.7% and Legacy Voice was 30%.

Revenue from this source declined 11.3% and will fall at a faster rate due to FCC’s reduced rates. Unfortunately, this segment has the highest margins. So, there should be overall margin compression.

Strategic Data

The Strategic Data source has three segments: Carrier Data, Enterprise Data, and IP Services. See Figure 1 below.

Lumos Strategic DataFigure 1: Strategic Data (Source Lumos Networks)

The Strategic Data contributed to over 50% of overall revenue and grew 16.7% in the third quarter.

Carrier Data

The growing consumption of data by cell phone users is putting a heavy burden on the nation’s wireless networks. The Carrier Data segment helps alleviate that problem by directly connecting the Lumos fiber optic network to cell towers. It is a very profitable investment. See Figure 2 below.

Lumos Fiber to Cell Investment ReturnFigure 2: Fiber to Cell Site Economics (Source: Lumos)

Lumos has an existing contract to double the number of connections to cell towers from 150 to 300 by the end of 2012. According to the original spin-off filing, it approximated that its fiber network was near 1,000 cell towers. In early 2012, Lumos estimated that 2,000 cell towers within 3 miles of their network. More recently, it estimated that 5,000 cell towers within a 10 mile network. It wants to double the number of cell sites every year.

This segment is the most important as it is not only profitable, but grew 25% in the third quarter and contributed almost 50% of Strategic Data’s revenue.

Enterprise Data

In the third quarter, Enterprise Data’s revenue grew 12% and contributed to 36% of Strategic Data’s revenue. The enterprise data revenue will grow as it connects more buildings to the fiber network. The number of on-network buildings grew over 20% to 1,150 from 949 last year. Lumos also has opportunity to up-sell to its existing enterprise customers.

IP Services

IP Services grew 8% in the third quarter, and contributed to only 18% of Strategic Data’s Revenue.

Valuation

At Friday’s closing price of $8.66, here are some of Lumos’s financial facts:

  • Market Capitalization of $186 million.
  • Enterprise Value of $486 million. It has a debt of around $300 million.
  • Adjusted 2012 forecast of EBITDA of $88 million.
  • 2012 forecast Capital Expenditure of $60 million.
  • Dividend of $12 million or $.56/share or 6.5% yield.

Obviously at a 2.1 ratio of Market Cap/EBITDA or 5.5 EV/EBITDA, the stock looks cheap. Also, most of the $60 million capital expenditure goes to future growth with very good return on capital. The big question that needs to be answered is that can the Strategic Data keep growing at a double digit rate to offset the decline in the Legacy Voice and Network Access revenue.

The growth largely depends on the Carrier Data segment. It has steady cash flow (5 to 10 year contracts with wireless carriers), and great return on capital. If it can grow the number of cell sites like it plans to, then this is a very cheap stock. However there are a couple of concerns:

  • The company has a contract to add up to the 300 cell sites. It has added 261 sites at the end of the third quarter. However, it has made no mention of any additional contracts after the 300 cell sites. 
  • It does mention that there are 2,000 cell sites within 3 miles and 5,000 cell sites within 10 miles. So, as it adds more sites, the return on capital will be possibly less and less as it is cheaper to add cell sites which are closer.
  • If it adds all 2,000 cell sites, and has EBDITA of $40,000 per cell site, the annual EBDITA would be $80 million/year. Although this would make the stock cheap, it is assuming the very best scenario.

As a result, I am keeping on the sideline with this stock to see what management says in the fourth quarter with regards to the cell sites. It wants to double the cell sites every year. So, the expectations will be that will add an another 300 sites next year. I will add a position if this is the case.

One thing to note that I did not mention is that this is a very competitive industry and Lumos Networks is a very small player. So, I will be very cautious with this company.

Here is the latest investor presentation.

Disclosure: I do now own LMOS  

Dean, Susser, CommonWealth, News Corp

Dean Foods

Dean Foods (DF) earnings are coming out tomorrow. The hope is that they disclose the potential sale of Morningstar in the report. The stock has been slowly going down. I still think it is undervalued. 

Interestingly, there is support on the stock today as a Barrons article came out with a favorable article. Their argument looks very similar to mine. Basically, it is undervalued if you factor out WhiteWave. Check out the article here.

Here is my valuation of Dean. The only difference is that I feel Dean will not use the full proceeds from the Morningstar sale to pay off debt. 

Susser Holdings

Susser Holdings Corporation (SUSS) came out with earnings that beat expectations. The market obviously likes the results and forward guidance.  The shares up more than a dollar on a down day. Read the earnings here.

I continue to hold a small position in the company with a target price around $47. I think the spin-off of Susser Petroleum Partners LP (SUSP) will accelerate the growth over the coming years. However, it is a volatile business so i am keeping limited exposure. 

My article on Susser is here.

Commonwealth REIT

Commonwealth REIT (CWH) came out earnings that beat expectations. The shares are down a little today. 

The company is very undervalued, but I do not trust management. I have been very critical about management and wrote a scathing piece on SeekingAlpha about the need to switch management. 

I have been in touch with smaller investors as well as bigger firms that hold millions of shares about possibly doing something to increase shareholder value. If you are a shareholder get in touch with me personally. 

I participated in this mornings conference call hoping to ask a question or two. However, I never got the opportunity. Anyway, I suggest investors read the call transcript as it was very funny. Lots of frustrated investors. I will post a link on the comments once it is up. 

The best way to play CommonWealth is buying long term call options. Read the article here.

News Corporation

News Corp (NWSA), one of the stock picks of HypeZero10, came out with earnings that beat expectations and is up today. News Corp is top holding of Donald Yacktman. His firm holds 80,556,339 share of the company as of September 30, 2012. He did reduce his position by 300,000 from June 30. 2012.

It is spinning-off its publishing unit and buying back shares. Here is the info about the spin-off:

On June 28, 2012, News Corporation announced that it intends to pursue the separation of its publishing and its media and entertainment businesses into two distinct publicly traded companies. The global publishing company that would be created through the proposed transaction would consist of the Company’s publishing businesses, its education division and other Australian assets. The global media and entertainment company would consist of the Company’s cable and television assets, filmed entertainment, and direct satellite broadcasting businesses. Following the separation, each company would maintain two classes of common stock: Class A Common and Class B Common Voting Shares. The separation is expected to be completed in approximately one year from the date of announcement. In addition to final approval from the Board of Directors and stockholder approval, the completion of the separation will be subject to receipt of regulatory approvals, opinions from tax counsel and favorable rulings from certain tax jurisdictions regarding the tax-free nature of the transaction to the Company and to its stockholders, further due diligence as appropriate, and the filing and effectiveness of appropriate filings with the SEC. There can be no assurances given that the separation of the Company’s businesses as described will occur.

Here are the quarterly results

Disclosure: I am long DF, SUSS, CWH. I do not own NWSA.

McGraw-Hill Spin-off

McGraw-Hill (MHP) is trying to separate its two companies, the financial unit (S&P Ratings) and the education unit, McGraw-Hill Education. It reported earnings last week and also updated investors on the timeline of the possible spin-off of McGraw-Hill Education. It expects to know within the “coming weeks” whether it will do the spin-off or sell the unit.

From a cursory look at the filing, and the fact the stock has had a quite a run, the stock looks fully priced. Check out the sec filing for the spin-off here.  

Disclosure: I do now own MHP.

Abbott Laboratories (ABT) Spin-off

Abbott Laboratories LogoAbbVie Inc. (ABBV), the pharmaceutical unit of Abbott Laboratories (ABT), sold $14.7 billion worth of bonds yesterday as it prepares to spin-off. Abbvie will distribute about $8.5 billion of the proceeds to the parent Abbot. “Abbott intends to use the proceeds it receives from AbbVie, in part, to fund its previously announced cash tender offers for certain of Abbott’s outstanding notes.”

Spin-off

After the spin-off, AbbVie will be a “research-based biopharmaceutical leader” with a portfolio of prominent drugs such as Humira, AndroGel and Duodopa. Abbot will contain four units:

  • Nutrition (Similac, Ensure, PediaSure)
  • Diagnostics (Immunoassay Diagnostics, Blood Screening)
  • Medical Devices
  • Established pharmaceuticals (branded generics portfolio)

Here are the details of the spin-offs:

  • Company: AbbVie Inc.
  • Ticker Symbol: ABBV
  • Key Dates: When-issued in mid-December. Regular-way trading begins 1/2/2013
  • Distribution: Distribution ration will be announced in December. 

Here are investor presentations for both companies:

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Disclosure: I do not own ABT

Wester Union Undervalued or Value Trap?

Western Union LogoWestern Union (WU), the money movement and payment services provider, recently reported third quarter results this past week. Although the results were not bad, the outlook was grim. In order to gain market share, the company expects to take restructuring costs, and more importantly lower prices. This will lead to lower earnings for the rest of 2012 and 2013. Investor reaction was swift, knocking the stock price from $18 to $12. At a 52 week low, is the stock now cheap?

Business

Western union has two business segments:

  • Consumer-to-Consumer. As you may have guessed, this is money transfer from one consumer to an another. This segment accounted for 84% of revenue and 95% of operating income for fiscal year 2011. 
  • Global Business Payments. This segment allows clients to make “one-time or recurring payments for consumers or businesses to other businesses.” This segment accounted for 14% of revenue and 10% of operating income for fiscal year 2011. (Note: Operating income numbers do not add up because rest of company lost money.)

Moat

Although they are trying to grow the smaller Global Business Payments segment, the valuation largely depends on the Consumer-to-Consumer business. In the Consumer-to-Consumer business, Western Union is the market share leader, garnering around a 17% market share in a fragmented industry. Moneygram International (MGI), its biggest competitor, accounts for just around 5% of the market.

Although, some investors are concerned about Western Union losing market share to digital competitors such as PayPal, the core company consumer sends money to a cash receiver. In this market, Wester Union is king. Their biggest advantage or moat if you will, is that they have a global network of 510,000 agents. Moneygram has less than 300,000 agents.

Their big network and presence allows them to charge a premium rate over their competitors. In some remote parts of the world, Western Union enjoys a monopoly since they are only agents in the area. As a result, they enjoy 60% of industry profits even though they only have a 17% market share. 

It is not easy for any company create this global network, and Western Union will continue to enjoy a premium price advantage due to it.

Industry

The global remittance volume is dependent on the global economy. It has been growing at a double digit CAGR rate and is expected to grow at around a rate of 7% over the next couple of year. See figure below.

Global Remittance VolumeSource: MoneyGram from World Bank 

Valuation

With a growing industry and premium pricing, one would think that Western Union’s net income would grow through the roof. However, that has not been the case. Net income has been fairly stagnant at around $1 billion/year since 2005.

Even though Western Union enjoys premium pricing over its competitors like MoneyGram, there is general pricing pressure in the industry. As a result to keep market share, Western Union’s revenue per transaction has been going down at a CAGR rate of 4.16% since 2006.  See figure below.

Wester Union Revenue Per Transaction  Source: 10K

Western Union has been able to grow revenue, maintain margins and maintain net income by increasing the number of transactions. Number of transactions per year has been growing at a CAGR rate of 8.95%. See Figure Below.

Wester Union Number Of TransactionsSource: 10K

If I could be confident that Western Union could at least maintain net income for a long time, I could assign a multiple to FCF and come up with a valuation. However, there are a couple of things working against Wester Union.

There is the constant pricing pressure on revenue per transaction that I just alluded to.

  • Customers that need to send money back home in remote parts of the world are paying super high fees to send just a couple hundred dollars.
  • Moneygram and other competitor’s prices are already lower than Wester Unions. Moneygram’s number of agents are growing at a higher rate than Wester Unions. Although, they will not catch Western Union anytime soon, they are putting more and more pricing pressure on certain corridors.
  • The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 already had an effect on this quarters revenue as 7,000 agents were dropped because they could not made compliant. Although, this act will not have significant revenue ramifications, there could be future acts that could have more of a lasting effect.
  • Although it does not affect Western Union’s core customers, competitors like PayPal are allowing consumers to send funds electronically very easily. In fact, PayPal and MoneyGram just signed a partnership where PayPal users can send funds to any MoneyGram location. This should have an effect on Western Union’s pricing and market share. 

The main reason for the gloomy forecast in the latest quarterly report is that management intends to lower prices to increase the number of transactions and gain back lost market share. The competitors will have to react to Western Union’s price cuts next year and they will cut prices. Then the price cutting vicious cycle will continue.

If you add the fact that global remittance volume is going to grow at a slower rate over the next 3 years than it has in the past, the best investors can hope for is that Western Union can maintain their net income of around $1 billion.If they can do that, then yes the stock is cheap at the current market capitalization of over $7 billion.

However, it is not worth investing in something that has limited upside and has so many things working against it. Therefore, even though this stock looks cheap from all valuation metrics, I am not investing in the company because I believe it is a value trap. 

Disclosure: I do not own WU.