Entries categorized as ‘Valuation’

Warren Buffett on his Investment Strategy

June 25, 2009 · 1 Comment

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We recently ran across an interview where Warren Buffett discusses several small strategies he employs when valuing a stock, in particular PetroChina, one of his investments at the time. An interesting suggestion on Buffett’s part is to read a company’s annual report before knowing anything about the company’s price or market value. According to him, this helps him get a more objective idea of how much a company may be worth.

When the interviewer asked something along the lines of: “How did you find Petrochina’s report when no one knew about it”? Buffett responded: “Well, some men read Playboy, I read annual reports”.

Categories: Valuation · Value Investing
Tagged: investments, petrochina, Warren Buffett

Eden Bioscience Corporation (NASDAQ: EDEN)

May 8, 2009 · 4 Comments

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We are adding Eden Bioscience Corporation (EDEN) to our ValueHuntr Portfolio. On December 5, 2008 the company announced its intention to dissolve, following the board’s consideration of strategic options to maximize shareholder value. The Company intends to hold a special meeting of shareholders to seek approval of the liquidation plan on May 20, 2009. At its current market price of $1.40/share, the company is trading at a discount to our conservative estimate of $1.64/share value at liquidation.

On an April 1, 2009 DEF14A SEC filing, the company’s management estimated a total liquidating distribution of between $1.27 and $1.42 per share. In particular, they expect to make an initial distribution of up to $1.00 per share within 45 days after the effective date of dissolution, and the rest of the distribution six months after dissolution has been approved. Our analysis indicates a slightly higher liquidation value than management has provided. However, investors should be aware that the margin of safety for this particular investment is smaller than in our typical case, so a smaller portfolio allocation would be desirable if this is in fact the case.

About

Eden Bioscience Corporation is sells harpin protein-based products to the home and garden markets in the United States. The company offers Messenger, Messenger Seed Treatment, and MightyPlant with Messenger Gold products for the protection of plants and seeds, and the promotion of plant health. Its products help plants to grow through stress and improve plants uptake of nutrients. Eden Bioscience sells its products through independent distributors and retailers.

On December 5, 2008, the Board of Directors approved the complete liquidation of the business. The press release indicates the following:

Eden Bioscience Corporation announced today that its Board of Directors determined, in its best business judgment after consideration of available strategic options, that it is in the best interests of the Company and its shareholders to liquidate the Company’s assets and to dissolve the Company. The Company’s Board of Directors approved a plan of dissolution and liquidation of the Company (the “Plan”), subject to shareholder approval. The Company intends to hold a special meeting of shareholders to seek approval of the Plan and will file related proxy materials with the Securities and Exchange Commission in the near future.

The Plan contemplates an orderly wind down of the Company’s business and operations. If the Company’s shareholders approve the Plan, the Company intends to file articles of dissolution, sell or otherwise dispose of its non-cash assets, satisfy or settle its remaining liabilities and obligations, including contingent liabilities and claims, and make one or more distributions to its shareholders of cash available for distribution, subject to applicable legal requirements. Following shareholder approval of the Plan and the filing of articles of dissolution, the Company would delist its common stock from NASDAQ.

In February 2007, the Company completed the sale of its proprietary harpin protein technology and substantially all of the assets related to its worldwide agricultural and horticultural markets to Plant Health Care, Inc. Since that sale, the Company’s business strategy has been to use any revenue generated by its home and garden business to support the Company’s continued operations while it explored whether there may be opportunities to realize potential value from the Company’s remaining business assets, primarily its tax loss carryforwards. Despite its significant efforts, the Company has been unable to identify an acceptable transaction that would enable it to implement this utilization strategy. At the same time, the Company has continued to incur net losses in its home and garden business. Given these and other circumstances, the Company’s Board of Directors, after careful evaluation of strategic alternatives available with respect to the Company’s future operations, concluded that the distribution of the Company’s assets in liquidation was in the best interests of the Company and its shareholders when compared to other alternatives.

On April 3, 2009 EDEN filed the SEC proxy regarding the company’s voluntary dissolution:

Dear Eden Bioscience Corporation Shareholder:

On May 5, 2009, we filed with the Securities and Exchange Commission our quarterly report on Form 10-Q for the fiscal quarter ended March 31, 2009 (the “Form 10-Q”). The Form 10-Q, which is enclosed with this letter, contains important business and financial information about our company and should be read carefully.

As previously announced, a special meeting of shareholders will be held on May 20, 2009, at 9:00 a.m., Pacific time, at the Country Inn & Suites By Carlson, 19333 North Creek Parkway, Bothell, Washington 98011, for the following purposes:

1. To consider and vote upon a proposal to approve the voluntary dissolution and liquidation of our company pursuant to a plan of complete dissolution and liquidation (the “Plan of Dissolution”).

2. To consider and vote upon a proposal to adjourn the special meeting to another date, time or place, if necessary in the judgment of the proxy holders, for the purpose of soliciting additional proxies to vote in favor of Proposal 1.

3. To transact such other business as may properly come before the meeting and any adjournments or postponements thereof.

OUR BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE “FOR” APPROVAL OF PROPOSALS 1 AND 2.

The proposal to approve the Plan of Dissolution requires the affirmative vote of at least two-thirds of the outstanding shares of our common stock and the proposal to grant discretionary authority to the proxy holders to adjourn the special meeting requires that the votes cast in favor of the proposal exceed the votes cast against the proposal. Therefore, it is very important that your shares be represented at the special meeting.

Valuation

At $1.40/share, we believe the company is slightly undervalued relative to our estimated liquidation value of $1.64/share, which implies a potential absolute return of 17% at liquidation. Our analysis includes off-balance sheet arrangements, cash burn assumptions from March 31, 2009 filing date to date of liquidation, and the costs associated with liquidating the company’s assets.

eden_balance

Off-Balance Sheet Assets

The company may be able to realize benefits due to its tax loss carryfowards. For the sake of conservatism, we assume no tax benefits in our analysis for liquidating value. The company’s latest 10Q explains the company’s tax situation:

The Company files a U.S. Federal and certain foreign and state tax returns and did not record an income tax benefit for any of the periods presented because it has experienced operating losses since inception. The Company’s total U.S. Federal tax net operating loss carryforwards were approximately $118.8 million at December 31, 2008 and expire between 2009 and 2027. The Company’s total foreign tax net operating loss carryforwards were approximately $4.3 million at December 31, 2008, of which $1.4 million expires between 2011 and 2018 and $2.9 million does not expire. The Company has total net operating loss carryforwards in 19 states that range between $12.6 million to $2,000 per state and expire between 2009 and 2027. The Company’s total general business credit carryforwards were approximately $1.4 million at December 31, 2008 and expire between 2013 and 2026.

If the Company were to undergo an “ownership change” as defined in Section 382 of the U.S. Internal Revenue Code (the “Code”), its net tax loss and general business credit carryforwards generated prior to the ownership change would be subject to annual limitations, which could reduce, eliminate, or defer the utilization of these losses. Based upon an analysis of past changes in the Company’s ownership, the Company believes that it has experienced ownership changes (as defined under Section 382) on March 20, 1996 and October 2, 2000 and absent any other ownership changes in the future, there are no significant limitations on the Company’s future ability to use net operating loss carryforwards generated prior to those dates. The Company does not believe it has experienced any other ownership changes that would further limit its future ability to use net operating loss carryforwards generated after October 2000.

Conclusion

We have added Eden Bioscience Corporation (EDEN) to our portfolio because at its current market price of $1.40/share, the company is trading at a discount to our estimate of $1.64/share value at liquidation, which represents an expected absolute return of 17% if liquidation is approved. However, already at the upper level of the $1.27-$1.42 guidance provided by management, the margin of safety for this investment is not as large as in our typical case.

Disclosure: We currently have a position on EDEN.

Categories: Liquidation · Special Situations · Valuation · Value Investing
Tagged: EDEN, eden bioscience, Liquidation

dELiA*s, Inc. (NASDAQ:DLIA)

April 22, 2009 · 3 Comments

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We are adding dELiA*s, Inc. to our ValueHuntr Portfolio. DLIA is a company selling for $58M, with 67% of its current assets in the form of cash or cash equivalents. The company’s net current asset value of $47M represents nearly 87% of the total shareholder equity, and it is significantly below our intrinsic value estimate of 115M.

 

On November 5, 2008, the DLIA completed the sale of its CCS business to Foot Locker. The company received aggregate cash consideration of $103.2 million for the sale of the CCS assets and assumption of certain related liabilities. This transaction significantly strengthened the DLIA’s balance sheet and recapitalized the company at a time when financial flexibility and liquidity is important.

 

The use of the sale proceeds has not been fully determined, but given the success of recent Delia’s store openings, we expect management to take advantage of retail opportunities within its core Delia’s brand and reduce general administrative expenses.

 

About

dELiA*s is a direct marketing and retail company comprised of two lifestyle brands – dELiA*s and Alloy – primarily targeting the approximately 33 million girls and young women that, according to published estimates, are between the ages of 12 and 19, a demographic that is among the fastest growing in the United States. The dELiA*s brand is a collection of apparel, sleepwear, swimwear, roomwear, footwear, outerwear and other accessories. The company currently operates 97 stores across the US, including 13 opened in 2008.

 

 

Valuation

 

Value of Assets

 

At yesterday’s closing price of $1.87, the company’s working capital represented nearly 50% of the total shareholder equity. Moreover, the company’s net current asset value of $47M represents 87% of the total market price.

 

We estimate the company’s assets are valued at $115M, or $3.70/share, with cash representing nearly 45% of the company’s total assets.

 

dlia_assets

 

The $103M in pre-tax earnings received from the sale of CCS assets increased the company’s equity by 18%, greatly enhancing shareholder value.

 

dlia_valuation

 

 

Value of Earnings

 

The P/E ratio of 4 analysts assign to the company is misleading, as it is clear that DLIA’s profitability in 2008 was masked by extraordinary income that would otherwise have caused the company to report a loss as in previous years.

 

The company was profitable in 2008 only due to the cash received from the discontinued operations of its CCS assets. If this sale is excluded, the company would have recorded a loss of nearly $13M, which is consistent with historical income results. Weinclude the cash received from this sale in our asset valuation, as equity is greatly improved due to the increase in current assets. However, we exclude the profit received from these discontinued operations in our earnings valuation.

 

In the 10K filed on April 16, 2009, DLIA reported a revenue growth of 7% (including both direct marketing and retail businesses) and an average same store sale growth of 2.8%, even in the challenging economic environment. However, expenses grew by 11%. The direct marketing business accounted for 102M in revenues in 2008, or 47%, while retail accounted for 53% of total revenues.

 

On average, DLIA has achieved an 8% annualized growth in revenues. However, these higher revenues have been offset by an average annual expense growth of 11%.

 

rev_exp_growth1

 

SG&A expenses have historically ranged from 61% to 66% of total sales. The company’s COGS have ranged from 42% to 45% of total sales. Our analysis indicates that the company would need to reduce general administrative expenses to 60% of total sales and COGS to 38% of total sales before the company becomes profitable. This means that the company’s management would need to significantly reduce its variable costs before we put a value on its earnings.

 

costs_goal

 

 

Conclusion

 

We think that DLIA is a case where the sum of its parts is significantly greater than the current value the market is placing on the company. Our analysis indicates that the company could become profitable by reducing its SG&A expenses to 38% of sales and its COGS to 60% of sales over the years. Obviously this estimate is assuming that expenses continue to climb at a similar rate they have historically relative to total sales. We believe this is a conservative estimate, as revenues have the potential to increase at a faster rate after the recession ends and consumers return to their old shopping habits. But because the company is not currently profitable, we rather not take the potential of future earnings into account in our intrinsic value estimate.

 

We believe the company’s assets are worth at least $115M, or $3.70/share, which is more than double the current market price of $58M, or $1.87/share, and this is placing no premium on the prospects of future earnings and assuming all warrants are exercised.

 

 

 

Disclosure:  The ValueHuntr portfolio does not represent an actual portfolio, and it is tracked for informational and educational purposes only. We do not have an actual holding in DLIA. This is not a recommendation to either buy or sell any securities.

Categories: Investing · Valuation · Value Investing
Tagged: delias, DLIA, nasdaq, Value Investing

Botox Earnings Put Crooked E in Stock Market P/E

April 2, 2009 · 1 Comment

(A commentary on Bloomberg by Jonathan Weil)

 

You can’t have a price-earnings ratio without earnings. And by one important financial benchmark, the Standard & Poor’s 500 Index doesn’t have any. The earnings gauge I’m referring to is called comprehensive income. While there’s a good chance you have never heard of this before, it’s a far more inclusive measure of profitability than the better-known subset, net income. The term also has a well- defined, standardized meaning under the accounting rules.

 

Comprehensive income is the change in a company’s shareholder equity during a given period, excluding the effects of new capital injections and dividend payments. By this measure, S&P 500 companies had combined losses in the past four quarters of about $200 billion, according to data compiled by Bloomberg and my own review of the companies’ financial reports. In other words, there is no P/E ratio, because there is no E.

 

By contrast, S&P 500 companies had about $295 billion of combined net income during the same period, which translates into a P/E ratio of about 25 times earnings for the index. That’s not cheap, by historical standards. And it’s a lot to pay for Botox earnings that are unnaturally stiff and cosmetically enhanced.

 

Polluted Measure

 

Investors might not pay much attention to comprehensive income. They should. Net income, regardless of its bottom-line reputation, has become so polluted that it’s no longer a reliable measure of profit or loss. A more accurate name would be comprehensive income excluding stuff that management wants you to overlook. The problem is about to get worse, too.

 

Starting this quarter, in a bow to pressure from the banking industry and its water carriers in Congress, the Financial Accounting Standards Board has proposed letting companies report net-income figures that ignore severe, long- term price declines in the stocks and debt securities they own. The way the rules stand now, companies must record charges to net income whenever they decide that such losses aren’t temporary.

 

In most cases, under the FASB’s proposal, companies would be able to keep non-temporary losses out of net income. That’s on top of several other things net income already excludes, such as gains and losses from retiree-benefit plans, certain derivative contracts, and foreign-currency fluctuations. All these will continue to count in comprehensive income.

 

Gap Widens

 

The gulf between net and comprehensive income usually isn’t as wide as it is now. Tally up the 2007 results for S&P 500 companies, and their combined comprehensive income was $784 billion, compared with $660 billion of net, according to Bloomberg data. That was back when corporate pension plans were comparatively flush, because of low interest rates and rising markets, and companies were more likely to show gains on their securities holdings than losses.

 

The past year’s sea of red ink, especially at financial institutions, has taken a toll on both profit measures. At some companies last year, the difference between the two was huge. General Electric Co. reported 2008 net income of $17.4 billion, and a $12.8 billion comprehensive loss. Citigroup Inc.’s $48.2 billion comprehensive loss was $20.5 billion wider than the bank’s net loss. Bank of America Corp. reported $4 billion of net income, and a $7.9 billion comprehensive loss.

 

Reason for Disparity

 

MetLife Inc. had a similar disparity, with $3.2 billion of net income and a $12.1 billion comprehensive loss. At Wells Fargo & Co., net income was $2.7 billion, compared with a $4.9 billion comprehensive loss. The differences in each instance arose from losses that had to be recognized on the companies’ balance sheets and equity statements, but not their income statements.

 

To be sure, if we excluded banks and other financial- services concerns, the combined comprehensive income for the rest of the S&P 500 index would have been slightly positive. Yet financial companies weren’t the only ones with vast differences between their net and comprehensive results.

 

International Business Machines Corp. reported 2008 net income of $12.3 billion, and a $6.1 billion comprehensive loss. AT&T Inc.’s net income was $12.9 billion, at the same time it had a $3.8 billion comprehensive loss. Boeing Co. had $2.7 billion of net income and a $6.3 billion comprehensive loss. All three companies have sizable defined-benefit pension plans.

 

Artificial Boost

 

Comprehensive income has many of the same problems as net. It depends on lots of subjective estimates — everything from when to recognize revenue, to the size of loan-loss reserves and depreciation expenses for hard assets. And just like net, it may get an artificial boost from a separate FASB proposal that would take effect in time for first-quarter results; this one would give companies more room to substitute their own judgments for market values when measuring their financial assets’ worth.

That said, comprehensive income is the closest thing there is under generally accepted accounting principles to an all- encompassing profit figure. The biggest challenge for investors often is finding it.

 

Although companies must disclose the number in the quarterly financial statements they file with regulators, they don’t show it on their income statements. Usually they list it on their statements of shareholder equity or bury it in the footnotes. Most companies don’t mention the figure at all in their quarterly earnings releases.

 

None of that will change, unless investors start demanding that companies disclose the information sooner, and more prominently. With another quarterly earnings season about to begin, the time to speak up is now.

Categories: News · Valuation
Tagged: bloomberg, Valuation