Friendlys Icecream

May 29, 2007

How did sleepy old Friendlys (FRN) restaurants land in the middle of a dramatic take-over battle? Here’s the “back-story” as I understand it:

Blake versus Smith: Founded in the 1930’s, the company was sold to Hershey’s, then spun off again. One of the founders (S Prestley Blake) owns over 10% of the latest version of the corporation, but has no part in management; indeed, he’s suing management. Meanwhile, Donald N. Smith, Chairman, who also owns over 10% has run Friendlys as part of a nearly unchanged 5-person board for about a decade.

Blake has accused Smith of mismanaging the company; e.g., trading in a $3 million aircraft for a more expensive $8 million one, running an office from Chicago when Friendlys has no restaurants in Illinois, paying staff at that office who do not do much for Friendlys (referred to as “FODs” — “friends of Don” by an employee in court testimony), and so on. These are all accusations, I do not claim them to be facts. Also, Smith has an interest in another company (“TRC”) that has various deals with Friendlys, and Blake accuses Smith of constructing these related-party deals for his own and TRC’s benefit, and not in the interest of Friendlys.

Blake also complains that Friendlys has taken on very expensive debt, and he has offered to lend the company $50 million at 2% over a specified floating benchmark rate, to pay off costly debt. The company responds that the pre-payment penalties would make that a bad idea.

Enter Biglari: Sardar Biglari runs the LionFund, and recently took over another restaurant chain (Western Sizzlin) in a hostile bid. Sometime in 2006, Biglari targeted Friendlys. Like Blake, he too criticizes the debt levels and management performance. (According to Yahoo Finance, in the last 3 years, FRN has had a cumulative near-zero cash-flow, a cumulative loss, and it has had negative net tangible assets. On the other hand, there have been profitable years, and the restaurants have a good reputation with customers.)

Management offered Sardar Biglari first one seat, then two, on an expanded board, but only if he agreed to conditions that would keep him in check for the next three years. This seems like an obvious attempt to buy time. Why would Biglari just sit on the board and nod? He rejected their offer. On March 6th, 2007, Biglari wrote a letter asking shareholders to vote him and an associate (Cooley) as directors at the next annual meeting. Biglari has billboards in Wilbraham, MA and Springfield, MA saying “Vote Biglari and Cooley”, and pointing people to his www.enhanceFriendlys.com website.

Perhaps seeing the inevitability of Biglari winning two seats, Friendlys put out a March 7th press release (i.e. the very next day), indicating that they had “…retained Goldman Sachs & Co., as financial adviser, and Weil, Gotshal & Manges LLP, as legal adviser, to assist the Board of Directors in exploring strategic alternatives to enhance shareholder value,...” Then, they postponed the annual meeting!

Friendlys’ website says: “The Friendly Ice Cream Corporation shareholder meeting originally proposed to be scheduled for May 9, 2007 has been postponed due to the previously disclosed alternative strategic review being conducted by the company’s Board. When the Board sets the date for a rescheduled meeting of the shareholders, the new date and time will be posted here.”

Ownership pattern/Proxy fight: From Friendly’s site, I got the following ownership figures (as of May 21, 2007):

  • Biglari Capital Corporation: 14.6%
  • S Prestley Blake: 13.1% [Founder, now suing Friendlys and Donald Smith]
  • Donald N. Smith: 12.2%
  • Kevin G. Douglas: 10.4% (Not sure who he is)
  • Various mutual funds (approx): 23%

With this ownership pattern, and with the possible backing of a few big mutual funds, Biglari appears to be an almost certain winner if there’s a proxy fight. So, it appears that current management is in its final days. Their only hope in not being forced out, is to get an offer that Biglari cannot refuse. If this happens, current shareholders win too.

Who’s the bad guy?: Is Biglari really trying to get rid of mediocre managers who have a poor record, or is he pouncing on a company that hit a temporary bad patch? Friendlys did have net income in some recent years, but a large loss in one year wiped out the cumulative numbers. Friendlys management says Biglari wants to use their company’s free cash fkow to finance other ventures, not investing in the restaurants. Answering this would require more details, and I’ll defer that for now.

Is FRN a buy?: What if no suitors are found? Even if Biglari gets the company, it may take a while, and some court battles; in the meanwhile, fundamentals could deteriorate (particularly with management focusing on this battle, rather than on running the company); the company he finally gets may be in a worse state than it is today. The stock has jumped since Biglari got into the stock. From $8 before Sept 2006, it is $14 today. Having risen so much, is the good news already reflected in the stock-price? This too would require more details, and I’ll defer that to a future post.

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Netflix/Blockbuster: bird’s eye view

May 11, 2007

I recently started to look at Netflix (NFLX) as an investment. My summary is that it’s a really interesting story, they’re a well-run company, but in a market fraught with uncertainity.

NFLX pioneered a channel that took business away from Blockbuster BBI. Finally, in the last quarter of 2006, BBI started to fight back, undercutting NFLX, causing it problems. NFLX has a clear and simple model, but BBI is adapting theirs rapidly and NFLX may be forced to react. To figure the value of NFLX, it is becoming more imperative to understand BBI than to understand NFLX itself. While NFLX executes well, its medium-term future depends more on what BBI will do and how NFLX can counter them.

Don’t shrug off BBI’s undercutting, saying they’re losing money. Price wars can get irrational, particularly when a competitor is fighting for its existence. Areas of research:

  • How much does BBI lose per TA customer? Estimates range from $2 to $42 per month; the truth is probably somewhere in between those numbers.
  • Next, what can BBI do to change those numbers? BBI’s management are obviously thinking hard about how they can use their loss-leader to make profit on something other than popcorn sales.
  • If BBI cannot sustain the current level of loss-leadership in TA, can they tweak it to reduce their losses, while still undercutting NFLX just enough to do real harm?
  • Finally, even if BBI fails after a few years of fighting hard, might that be a few years too many for NFLX?

In the longer term, the channel is threatened by downloading.When it comes to downloading, other players like cable and ISPs will also want in on the game. One can anticipate another fight, (say) six years down the road.

Therefore, what we have is this: NFLX is a well-run company, in a market that’s in flux, with a competitor that’s desperate; and, the future, instead of ending in a winner, morphs into a different fight. In summary, from a bird’s eye view, NFLX looks like a good company, but in a business that may not be too profitable in the medium-term and has little long-term visibility.

And yet…, it’s all so interesting. It’s seductive for an investor to want to rise up to the intellectual challenge of predicting a winner. That challenge, after all, is why so many people like investing. Despite thinking that it’s unpredictable, I too am drawn to the story, and will probably look more closely. I’ll resist the urge to bet any money just yet.


PFN

September 29, 2006

March 2006: This is junk (BB), but it is run by PIMCO, so that lets me sleep easy. It’s a floating rate trust, which yields 8.5% today. Then interest rate tightening cycle has not ended, so there’s no reason to believe the yield will fall.

If Bernanke raises a couple of times and then let’s things remain steady, it may be time to sell, before the yield collapses, and the price does too. Right now, it seems that won’t happen until Q3 or Q4 at the earliest.

Sep 2006: The interest rate cycle might be at a plateau, for a few months at least. PFN has not fallen. In fact the price ($18.90) and yield (9%) have both risen slightly over the last 6 months. Review again in Q1 of 2007. [Update Feb 2007: Fed rate still steady. PFN yield @ 9%, but a 4% premium has built up in the price — $19.20 now]

Update Jan 2009: With the crash in the market, PFN went below $6, with a yield going arounf 17%. It is now $7.60, up a little bit from it’s lowest, but still yielding 14%. People are worried about all types of debt, particularly the low-grade stuff in this fund. In addition, the fund (like many other such funds) is leveraged about 30%. That debt is short-term and constantly renewed. A credit crisis raises short-term rates (private rates like LIBOR) even while the Fed is lowering it’s rate. So, that fear also hit the fund.

At these yields, the fund looks attractive to me, and I still own some.


GM

July 28, 2006

GM just announced a loss for Q2-2006. However, the major cause was the restructing costs (previous post on GM). The car business itself did better than expected. Non-US did well, but US-cars did better than expected too. The stock chugged up from $26 to $32 over about a week of the announcement.

After the flurry of news about Nissan/Renault’s Goshn meeting Wagoner, things have gone quiet. Reading Jerry Flint’s Forbes article I had a thought: wat if Goshn’s long-term plan is not a Nissan-Renault-GM triumvirate? What if he really wants a GM-Nissan partnership, ditching Renault (and his French government partners) when the time is right?

Updated: Nov 22nd, 2006 – I closed my long GM position today as I don’t expect it to do much in the near future. I started a long GM position by shamelessly and blindly following the Longleaf guys into the stock. I got lucky when Kerkorian agreed with them and when he pushed for a tie up with Nissan. I still think GM is probably a stock for the long haul — the uncertainity comes from not knowing how the 2007 union-contract renewal will turn out.

Today, a negative remark by the UAW president reminded me that I had planned to sell just before people started to take the union seriously. The likely scenario is that the union will be completely uncompromising leading up to June/July 2007, and might even make investors really nervous about the stock. So, that’s the time I’ll get back in; because I believe the union will end up “giving up” far more than most people expect.

Update Jan 2009: I’m glad I got out of GM (at a marginal profit). I gave up on my plan of getting back into GM, as Kerkorian and Nissan walked away.


PHM

July 10, 2006

Summary:I ought to buy some PHM; only, not just yet

I like everything I’ve read about Pulte Homes (PHM). Though I did not know it when I bought it, I live in a Pulte home. when I first got interested in PHM, their stock was booming. So, I kept out. In the 2004 Barron’s “Roundtable”, one participant recommend shorting PHM. Turned out he was early. When the 2005 “Roundtable” came around, the stock had not moved significantly up or down. The “guru” reiterated his short and this time it turned out to be good advice. I didn’t take the advice either time. I figured I wanted to buy PHM when it was sufficiently undervalued. Here’s a chart, from Yahoo finance.

phm.png

Bill Miller and Ruane Cunniff have been buying PHM since early 2005, and it is down about 20% from their purchase price. I don’t understand their timing, except that they were buying @ around 25% off the 52-week high. Still, given that housing had only just begun to slow down they seem to have been early.

At today’s prices, PHM is extremely tempting. If it paid a higher dividend I might have bought and waited. However,

  • I’m still not convinced we’ve seen the worst of the home-sales situation. There has been a slow downward drift, but no capitulation. The financial press and its readers know that a slow-down in housing is here, but the “man on the street” does not.
  • The Fed is most likely not yet done with raising rates, so mortgage rates probably have a little rise left in them

In a recent WSJ interview, Ken Heebner (of CGM Realty) said he thought housing still had some downside to it. He said that sellers are offering incentives and are also in the stubborn stage where they are hoping to get a price for which sellers aren’t available. The next stage ought to see a capitulation in the form of significant price falls in selected markets. This, in turn, should put pressure on the new-home builders.

So, even though PHM is extremely tempting (at a PE around 5!) I am going to hold off for a little while more. If PHM ($29 today) does break out and head near $32, I might lose patience and buy it.

Update (July 22): PHM went down to $27, and it took a lot of will-power not to buy some. I’m pretty sure it’s a bargain at this price if one buys with a 5 to 10 year perspective. Problem is that housing still has not hit bottom, and I cannot believe that all the bad news is priced in … it seldom is.

Update (Aug 11): Toll Brothers has said that orders are down 47%. Meanwhile apartments are doing better than in the last few years. Forbes reports that “Through June 30, Economy.com shows housing sales have fallen 8.2% to 5.81 million from 6.33 million last year.” Bottomline: The cycle unfolds predictably (in terms of direction if not size and duration).

Update: See follow-up post here.


C

June 26, 2006

C is around $49 and paying $2 as dividend.
The Jan 2008 $45 calls are around $7.40
So, best-case scenario (if one buys the stock and sells a covered call, and if the stock stays or goes up), would be:

Outflow: ($48.55 – $7.30=) $ 41.25 [This is after deducting commissions]
Inflows: Dividends (June 2006 through Jan 2008=) $ 3.00
Final Inflow (Jan 2008 option assignment=) $45
Profit ($45 + $3 – $41.25=) $ 6.75
That’s about 16% on the original outflow

Obviously, downside risk if it goes below $45.

$41.50 + 5% = $43.30 … So, as long as C does not drop another $6 (11%) from it’s current position, I should make 5%.

If it goes back to the $40 level, I should consider repeating a scaled down version of the above — as long as dividends appear safe.

(Updated– July 23rd): I should add that I prefer Chase to Citi, but already own Chase. Also, I expect Chase to be more than a place to “park” money for a few years.

(Updated– Oct 10, ’06): C is $50.80 and the $45-call is $7.80 [net holding = $43] . So, my capital gains are about $3.50 per share if I cash out today. The dividend for the last 5 months adds a little over $.50 to that.
Next question is, should I continue to hold it? Since the combination is now worth $43 (as opposed to $41.25), the remaining dividend @$2 and the $2 increment from $43 (current value) to $45 (call strike) comes to a sum of $4, which a year works out to 9.3%, which isn’t as good as the original, but still good enough to keep me holding the stock.


Home-builder stocks

March 13, 2006

Summary: The slow-down is just starting 

For a few years now, there has been talk of a coming bust in housing. Most commentators don’t expect a bust in the stock market sense, but more of a plateauing for a few years, where prices don’t move, and not as many new entrant buy homes. Indeed, in some states, this might already be underway. [Where do I get these figures?]

In the last 2 Barron’s “round tables”, one investor recommended shorting the builder’s stocks (Pulte, Toll Bros. etc.). The stocks have finally come way off their highs, having peaked around July 2005.

Reading Pulte’s report, I find that demand is still high for their homes. Does that mean the bad news is in the future? or that the markets are expecting worse than what is really to come? Toll Bros. stock has fared much worse than Pulte; their report says that home prices have stagnated in most of their markets. It also says that demand has been weaker in the last quarter.

With things like this, the bad news trickles out. So, my guess would be that these stocks have at least another year of sideways or downwards move before we get to real depression.

Here’s what Freddie Mac’s chief economist says (Mar 9, 2006:
“Although the signs are mixed, the housing industry is now beginning to shift into slower gear, and higher mortgage rates will only strengthen that change. We expect housing starts to wane by over five percent in 2006 and home sales to ease by about four percent. However, we see no signs of a bursting bubble, but rather a return to a more normal pace of activity.”

and
For many months economists have been speculating that the housing market was about to change course … Yet the statistics refuse to definitively indicate the direction of the market. The Conventional Mortgage Home Price Index for the fourth quarter of 2005, released March 2nd, showed that annual growth in home values hit 13 percent nationally. Housing starts in January hit 2.28 million units, the highest pace since 1973. No signals of a cooling housing market here. But sales of both new and existing homes fell in January and the inventories of existing single-family homes and condominiums for-sale rose to their highest levels since 1999. These contradictory statistics are signs of a slow down.

Freddie Mac is projecting 2005 to be the peak year for both sales and housing starts, with the numbers going down all the way into 2008. However, in Jan 2004, they were predicting that 2004 would be the peak year, with things going down in 2005 and beyond. I guess the lesson is that we’ll know a year was the peak when we actually see a year that went down. And it still won;t be too late.

In other words, it might take till Q1-2007 before people are convinced that the peak in housing was for real [or, alternatively, to continue to think it is just around the corner]. Given this, there does not appear to be any upside for housing stocks in 2006.

(See this post for more on home-sales.)