Street Capitalist: Event Driven Value Investments

Sir John Templeton said something like: the best time to buy is at the point of maximum pessimism. A few months ago, I wrote a post (Special Situation: IACI Interactive Break-Up) detailing the prospects of a breakup of IAC/Interactive (IACI). At the time, I detailed how a number of the business units could be highly attractive on their own. Right now though, the certainty of such a break-up is extremely unclear, however IACI still offers an attractive return, even without the balance sheet event.

Usually, whenever news comes out about a potential break-up, the price of the company spikes. IACI was no different in this sense, it appears as if the company traded around $27 to $28 per share prior to the news release, and eventually spiked to $31. Now, IACI is trading for as little as $19.46.

I believe IACI offers a good margin of safety with great upside. The company is trading at levels that haven’t been seen in 5 years. The current price is barely above its 52-week low. The trigger for this is most likely a result of two factors

1. The company’s quarterly earnings failed to meet analyst expectations, a large loss on behalf of the Lending Tree segment resulted in an EBITDA of only $210 million versus the projected $257 million.

2. The protracted court struggle between Barry Diller and John Malone means that any ruling on a potential value creating break-up wont come for a while. The near-term prospects of Lending Tree don’t look good which is one of the reasons Diller is trying to argue in favor of the spinoffs.

Many of the other business units of IACI have been performing relatively well. For Ticket master, revenue is up 27%. In spite of a questionable consumer environment, HSN (Home Shopping Network) reported a 3% increase in revenues, and “New IAC” which would be home to internet properties such as CollegeHumor.com is showing a 21% jump in revenues. Best of all, Interval International, the time-share vacation property segment, grew revenues at a rate of 35%. With business segments growing at these rates, the -55% drop in revenue from Lending Tree seems to be mitigated and an investment in IACI could be opportune at this moment.

Valuation

If you look up IACI on a financial screener, you will see that the company is “trading below book” at 0.65. However, for companies like IACI, this isn’t the best of measures. A liquidation scenario would not work properly due to the lack of hard tangible assets, a lot of IACI’s depends more or less on an increased use of their online services.

Now that we’ve established a fault in the P/BV system, we can try applying a more effective method, Enterprise Value / EBITDA. Using this we will obtain a multiple, and then we can compare it to the levels of companies within a similar industry. Since IACI is so complex, yet holds a number of media assets, a good choice would be a comparison with Newspapers which hold non-traditional assets, a good choice of comparison for multiples would be the EV/EBITDA of the New York Times or Washington Post.

Current Share Price: $19.43
Shares Outstanding (Diluted): 335.29
Market Cap: 6524.74

+ Debt 946.42
- Cash $1585
-Minority Stakes $293.2

EV = $5,592.96
Est. 2008 EBITA: $960

Now, if we take this new EV and utilize an estimation of the 2008 EBITDA of IACI, and then take $5,592.96 and divide it by the 2008 EBITDA estimation, we see that IACI may be trading at a low level of 5.8X. This is quite low when compared to more traditional newspaper EV/EBITDA multiples which range from 8x-9x. If IACI traded at these multiples, its shares would range from $26.80 to $30.20 or a potential 37% - 55% return.

This does not really take into account some of the revenue potential of newer business segments in IACI, such as the new websites like CollegeHumor or the growth of the company’s real estate segment.

Either way, at its near historic lows, from this valuation IACI seems to have a significant upside.

Court Case

The current legal maneuvers seem to be indicating that it is not Liberty Media’s intention to block the company from breaking apart all together. Most likely it is that John Malone is hoping to pick up the HSN business segment without having to compete with private equity bidders or make a bold and pricey tender offer to buy the HSN in the public market.

It is hard to argue with John Malone here though, it seems clear that as per Liberty and IAC’s agreement, both parties need to agree before making any changes which could disrupt the ordinary course of business. In any case, with the current valuation of IACI as just one sole entity, there is still significant upside, meaning that any balance sheet event - such as a break-up and spinoff of all the units would result in an extra benefit. Each individual business unit would be able to trade at a greater multiple because they would not be discounted for slower growing or declining business segments.

Outlook

During this last quarter IACI missed earnings estimates mainly due to LendingTree. As a result of the growth from newer business segments, I feel like the current market reaction is overblown and the business is still undervalued. In addition, an end to the current legal troubles would at least reduce uncertainty and help IACI’s price.

On January 29th, Steak N Shake ( SNS ) sent a letter to Sardar Biglari, of the Lion Fund that they would offer him two board seats but also amended shareholder bylaws in order to to increase the number of outstanding shares of common stock required to request a special meeting of shareholders from one-fourth to eighty percent.

The result of such action would be a significant set back in Sardar’s plan to gain control. Here is his response:

Dr. John W. Ryan
Chairman of Nominating/Governance Committee
The Steak n Shake Company
500 Century Building
36 South Pennsylvania Street
Indianapolis, Indiana 46204

Dear Dr. Ryan:

I received your letter of January 31, 2008, which offered my colleague, Philip L. Cooley, and me each a board seat. Unfortunately, in the same letter, you informed us that the board amended the company’s bylaw provisions to effectively remove the option for shareholders to call a special meeting. The bylaw amendment to require the holders of 80% instead of the former 25% of the shares outstanding in effect eliminates a fundamental shareholder right to call a special meeting. This revision provides the board immunity, not accountability, and reveals a culture to which we cannot subscribe.

We accept your offer of two board seats provided that the board restores the shareholders’ prerogative to call a special meeting when the votes from 25% of the shares outstanding are cast. Our acceptance of board seats would also require that the board adopt an additional provision that future revisions to this bylaw require shareholder approval. We have made a promise to Steak n Shake shareholders to protect their interests, a promise that we intend to keep. You, too, should think about your fiduciary duty and reputation.

Needless to say, as a byproduct of limitations on shareholder rights and privileges, the costs of a proxy fight and potential litigation pale in comparison to a decrease in the value of everyone’s shares. Curtailing an owner’s power is exactly the kind of behavior we do not approve of. Moreover, shareholders own the company and should be able to vote anyone on or off the board.

I trust that you as Chairman of the Steak n Shake Nominating/Corporate Governance Committee will make the right decision and fulfill your duty and obligation as a board member of a publicly traded company.

Sincerely,

Sardar Biglari

I’m quite glad that Biglari is making the demand for the bylaws to be changed back, it would be significantly more difficult for him to affect the kind of change he needs in order to create and unlock value at Steak N Shake if he is unable to gain more control.

So far though, it seems as if management is at least somewhat receptive to him seeing as they’ve already offered him a bit of an olive branch, but they definitely need to do more.

Times are pretty crazy. With the volatility of last week a lot of panic ensued. I hope all of your investments are doing well, I’m a little nervous about some companies that appear cheap. A few value investing bloggers are jumping into monoline insurers like Ambac (ABK) and I think that perhaps these types of investments are not prudent. I don’t think you need to strap on your helment and start shooting. Try to take some time to really study investments in financials, don’t just assume because their names are big that they will be around forever. A lot of their long-term success may depend on capital infusions which could dilute your shares. And really, do you want to invest in a company with the hopes of some SWF swooping in and proping your company up? Or do you really want to invest hoping for a government bailout? Do you want to compete against Berkshire Hathaway’s new insurer? I think that borders too much on the risky side of things, and would prefer to stay on the sidelines.

I started this blog in September and created a portfolio specifically for it, that way I can document how my investments have been doing along the way. So far, things are looking good.

Before I begin:

New Position - Steak ‘N Shake

I postponed on mentioning this, because I kept debating whether or not I should purchase more. After listening to the conference call, I decided to keep my position at its original average cost - $11 per share. This means that I’m down roughly -33% so far on Steak N Shake (SNS) and it has only been about a month. The reason I decided not to dollar-cost average down was that I still wanted to maintain my concentrated by lagging position in Odyssey Re - and I was not thrilled with anything mentioned in the conference call.It seems like Steak N Shake will be a special situation with good potential upside, but for now I see few catalysts on the horizon to make the company appreciate value immediately. SNS represents 10.7% of the Street Capitalist Portfolio.

Other investments:

1. Fairfax Financial Holdings

I’ve been most thrilled with how Fairfax Financial has performed over the course of the blog. My average purchase price was $215 a share, in early September. Today, Fairfax Financial Holdings hit $326.41. FFH had been on my watch list for quite sometime, but I felt uncertain about a catalyst to really make it appreciate its value, especially confronted with the massive short campaigns of various hedge funds.What peaked my interest was their CDS portfolio.In early September, I spent a good deal of time analyzing some macro issues and comparing them to possible value investments. I believe that this is a good strategy, and Julian Robertson’s success is really evident of that.

Since February of last year I actually started following what had been going on with sub-prime mortgage lenders and decided their business wasn’t very viable. I was a little astonished when after March, some investors began plunging into sub-prime lenders with hopes of picking up a nice 5-bagger. Then, when I read a paper from the Jackson Hole Summit, my conviction to figure out a way to get exposure to the short side of sub-prime. The paper, detailed how in most cases, countries with easier access to credit typically have consumers who heavily leverage or at least employ leverage to augment their consumer spending.

Since I believe that consumer spending has a major impact on the way our economy moves, I became pretty bearish and decided to take a position.While I don’t have access to credit default swaps, and I wasn’t confident in directly shorting a Delta Financial or Countrywide, FFH seemed like a good bet. Prem Watsa is a great investor who I feel has considerable foresight, the stock didn’t seem to be followed very well / seemed to be hated quite a bit by big money — resulting in a company that from a P/B perspective looked quite attractive, with a great CDS portfolio to add some extra oomph.My position in FFH has achieved a 51.82% return in a little less than 5 months. I wasn’t the first to the Fairfax party, but I feel like I came in at a pretty opportune time. While price targets for the company range from the $320 - $360 range, I’m quite sure that I’ll be in it for the long haul.

Fairfax Financial Holdings (FFH) makes up 44% of the Street Capitalist Portfolio.

2. Odyssey Re Holdings Corp.

A lot of the same factors that influenced my FFH investment influenced my ORH position. At about 25% of the Street Capitalist portfolio, Odyssey Re (ORH) is a pretty considerable position. Trading at about 1x book, not followed well, and holding a good CDS position still makes it very attractive to me. Since I bought FFH and ORH at the same time, Odyssey Re has lagged behind, it’s only up 6.76% for the same period, versus Fairfax’s 51.82% return.Ultimately though, I don’t feel the need to sell ORH and believe it will become valued over time, albeit a little longer than FFH.

3. Esmark Inc. Esmark (ESMK) is 19% of the Street Capitalist portfolio and its worst performer. So far I’ve lost -50% on this position, which hurts my overall performance. Basically this was another special situation idea that I feel still has a lot of promise. As long as Esmark can pull off the Sparrows Point acquisition, they should be able to do relatively well. It seems as if union support by both groups will certainly help with this, they may just need to find better partners. I’m not really worried and will hold on to the company.

4. Steak N Shake

There’s not too much else that I can mention here, I was pretty disappointed with management’s lack of receptiveness during the conference call and their general ambiguity. I believe that Sardar Biglari’s ability to win board seats certainly looks probable.I’ve included a number of links related to Steak N Shake below:

A Special Situation at Steak N Shake (Motley fool)

Steak N Shake (Gurufocus)

Overall:

As a whole, the Street Capitalist portfolio is up 12.82% over the course of less than 5 months. During the same period, the S&P 500 is down -6.46%. I’m quite satisfied with this type of out performance of my benchmark. In the future I’d like to make a few more changes. Holding just four companies is incredibly concentrated, and while I don’t entirely object to this, I do believe it would be a good idea to hold more just to safeguard against any unintended stupidity on my part. I was pretty inspired by Mohnish Pabrai’s performance considering DFC’s bankruptcy while ABXA and CCRT nose dived. Overall, Pabrai was able to maintain a positive return year to date Thanks Anonymous for catching an error - I misread PF2’s year return as positive 1.2%, when it was really -1.2%. Still though, not a bad drawdown considering there was one bankruptcy and multiple positions which lost greater than 30%.

My current watch list:

WellCare (WCG), Sears Holdings Corp (SHLD), Marvel Entertainment (MVL), Wyndham Worldwide Corp. (WYN)

I’m in the middle of final exams till Monday, so I haven’t really had any time to write original content to post up here. Till then, check out some good articles/blog posts I’ve seen recently, all of these are great reading.

Nick Nejad posts notes from Warren Buffett’s talk in San Francisco:

Q: Your views on the US Dollar?
A: The most important question to ask in economics is “X happens, and then what?”. We are living prosperously but every day we are sending 2 Billion dollars overseas because we consume more than we purchase. It is similar to if we owned say a large farm in Texas. We are extremely wealthy, but every year we mortgage a little bit of that farm in order to enjoy more of the present. And it is gradual, but then at some point you have to spend an hour or maybe 2 hours a week of your work to go towards servicing this debt. The problem is at some point either foreign investors will stop financing our consumption, or our future generation will be burdened with a debt and have to work some X hours towards servicing the debt of the earlier generation. But the present over-consumption is unsustainable.

Q: Your views on new products such as derivatives, SIVs, etc. ?

A: There’s utility in securitizations. But the problem is these have become complex and the originators and investors have been stretched so far in part in the whole process.

Full Notes on the Warren Buffett Talk

Allison Connolly’s article on the Esmark/Mittal Steel/Sparrows Point deal is an important read for anyone who owns shares in Esmark. I do, but the company itself makes up a pretty small part of my portfolio. Still, the uncertainty of the Sparrows Point deal has sparked a 40% drop from where I purchased Esmark (ESMK) — which used to be WPSC, and it will be an interesting situation to watch as it unfolds. I think even if the sale falls through, the company will remain undervalued, so I may be averaging down on my position in the near future.

The deal to sell the Sparrows Point steel mill to E2 Acquisition Corp. is in flux as discussions continue while possible new partners wait in the wings.

Two self-imposed deadlines have come and gone as ArcelorMittal and E2 and the United Steelworkers union have tried to hammer out a final agreement. Because of the delays, agreements between E2 partners and Chicago Heights, Ill.-based Esmark Inc., which is leading the joint venture, have expired.

Full Article on Sparrows Point Sale via Baltimore Sun

Kate Kelly’s article on Goldman Sachs and their bearish sub-prime trades is another great read. The traders at Goldman did an outstanding job with going short sub-prime, and the article really highlights Goldman’s risk management and bet-sizing:

The subprime-mortgage crisis has been a financial catastrophe for much of Wall Street. At Goldman Sachs Group Inc., thanks to a tiny group of traders, it has generated one of the biggest windfalls the securities industry has seen in years.

The group’s big bet that securities backed by risky home loans would fall in value generated nearly $4 billion of profits during the year ended Nov. 30, according to people familiar with the firm’s finances. Those gains erased $1.5 billion to $2 billion of mortgage-related losses elsewhere in the firm. On Tuesday, despite a terrible November and some of the worst market conditions in decades, analysts expect Goldman to report record net annual income of more than $11 billion.

How Goldman Won Big On Mortgage Meltdown