Insight From Einhorn’s Latest Picks

Greenlight Capital, the hedge fund run by famed investor David Einhorn, just came out with their quarterly letter to share holders. He had interesting comments on some positions:

Apple (AAPL)

Apple is Greenlight’s largest position. Greenlight bought back the Apple shares it had sold in the third quarter. In my last article, I advised readers to stay on the sideline on Apple shares. Obviously, Apple took a big hit today after reporting quarterly results yesterday. Even at $450, I would continue to be cautious and stay on the sideline. If it hits near $400, I will most likely initiate a position, but as I mentioned before this stock does not have huge upside. So, it makes sense to be cautious. 

General Motors (GM)

General Motors is one of Greenlight’s top holdings. He is still bullish on GM even after the recent run up. I agree and am still long GM. It has multiple catalysts:

  • Buy back even more of its shares from the government. They already bought back 11% which should increase eps.
  • Lower pension risks further. It announced last year that Prudential would administer and pay $26 billion of its pension obligations at a cost of $3.5 to $4.5 billion to the company. It can use the excess capital to move more of its pension obligations to Prudential.
  • United States vehicle sales return to a more normalized level as the economy picks up.
  • Europe economy picks up.

Marvell Technology (MRVL)

Marvell used to be one of Greenlight’s top holdings. However, the stock has been one of his worst performers. Earnings and revenue have been down. Recently, a jury awarded Carnegie Mellon University (my alma mater) $1 billion for patent infringement. Einhorn thinks that award will be reduced and the market is also discounting a new product cycle. 

I am avoiding Marvell because I am not confident that the patent infringement award will be reduced and do not understand its products well enough to make an investment.

Vodafone (VOD)

Vodafone is by far the most interesting of Einhorn’s stock picks. According to Einhorn:

  • It pays a 7% dividend.
  • It owns 45% of Verizon Wireless.
  • It trades at 12 times cash earnings excluding the Verizon Wireless ownership.

This definitely seems like a great investment. I will look more into Vodafone this weekend and share my findings.

Here is the letter.

Disclosure: I am long GM.

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.

 

GDE Error: Unable to load profile settings

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. 

Buy Xerox


Xerox LogoXerox (XRX)
just reported their third quarter results. Due to a challenging macro environment and government budgetary pressures, operating margins decreased 1 percentage to 8.6% and this had a negative impact on profits. Investors were not impressed and sent the stock down 7.8% to $6.48. However, the lower stock price is an opportunity to buy shares at a very cheap level.

Business

Xerox has three business segments that generate almost $23 billion in yearly revenue:

  • ServicesServices has three offerings: Business Process Outsourcing (“BPO”), Information Technology Outsourcing (“ITO”) and Document Outsourcing (“DO”). Services allow customers to run day-to-day business operations. It contributes over 50% of revenue and is the companies revenue growth driver.
  • Technology. Technology “includes the sale of products and supplies, as well as the associated technical service and financing of those products.” It contributes over 40% of revenue, and the company is focused on maintaing revenue while improving margins.
  • Other.The Other segment “primarily includes revenue from paper sales, wide-format systems, and GIS network integration solutions and electronic presentation systems.” It contributes about 6% of revenue is not profitable.

83% of the companies revenue are recurring (“Annuity”). “Annuity includes revenues from services, maintenance, supplies, rentals and financing.” The other 17% come from one time equipment sales. 

Valuation

Bullish case for Xerox:

  • In a challenging year, the company is on traget for $2 to $2.3 billion operating cash flow and $1.5 to $1.8 billion of free cash flow (FCF). The current market capitalization of the company is $8.3 billion. They are trading at around a price/FCF ratio of 5. If they trade at a ratio of 8, there could be 60% upside to the stock.
  • The company is returning money to shareholders. $1 billion will be used to buy back shares in 2012. $300 million be used for dividends. The company has a 2.5% dividend yield.
  • The company can still improve profitability by cutting costs.
  • 83% of revenues are recurring and company is focused on growing the services division which has more of the recurring revenue.
  • The company is targeting 15% earnings growth over the next coming years.

Risks

  • In a very competitive industry. In services division, competition comes from Accenture (ACN), Aon (AON), Computer Sciences Corporation (CSC), Convergys (CVG), Dell (DELL), Genpact (G), Hewlett-Packard (HPQ), IBM (IBM) and Teletech. In technology division, competition comes from Canon (CAJ), Hewlett-Packard (HPQ), Kodak, Konica Minolta, Lexmark (LXK) and Ricoh (RICOY).
  • Revenue and margins are down this year even though the company spent $200 million on acquisitions. This can be partly blamed on the economy. A lot of the aforementioned competitors like IBM have lower revenue, but unlike Xerox they have  been able to make it up by cutting costs. Xerox is not the strongest of the competitors, but in a stable economy they should be able to at least maintain revenue and margins. 
  • $9 billion debt load. However, this debt load should come down to $8 billion by the year end and over $6 billion is backed by finance receivables. 
  • There is no catalysts for a higher stock price. 

David Einhorn

One investor who agrees is David Einhorn of Greenlight Capital. Here are his comments earlier this year. 

“XRX is a document management provider that entered business process outsourcing when it acquired Affiliated Computer Services (ACS) in February 2010. The combination allows XRX to sell more value-added services to its current customers and apply XRX’s technology to deliver ACS’s services more cheaply. This is our second investment in XRX since the acquisition. The first time, we bought with the stock price around $9.35, and sold with a modest gain over concerns about XRX’s Japanese exposure after the earthquake. That issue appeared fully discounted by the market during the fourth quarter when we re-established a position at $7.61 per share, which is less than 8x estimated 2012 earnings. In the first nine months of 2011, XRX signed a significant amount of new multi-year outsourcing services contracts. XRX has been aggressively cutting costs within the legacy ACS organization. Over the long-term, XRX is expecting over 6% revenue growth and 10-15% adjusted EPS growth. XRX expects to spend $1.0-$1.4 billion on share repurchases in 2012, which should make a good dent in the share count given its current equity capitalization of $11 billion. XRX shares ended the year at $7.96 each.”

Since these comments, Greenlight has added to their posistion. As of June 30th, 2012, they held 26 million shares. Greenlight will report their next quarterly holdings in the middle of November. 

Conclusion

Xerox trades at a cheap price/FCF ratio of 5. They should be able to at least maintain that FCF over the coming years. If so, they should trade at least at a price/FCF level of 8. This would mean a 60% upside in the stock price.

Disclosure: I am long XRX