As discussed in our slide/video presentation posted the other week, we've been through the psychological ringer over the past two years. We've moved from shock and awe, to realization and, now -- in our view -- acceptance:
While we believe economic data suggests stability, plenty of challenges remain and mixed signals emerge each day, with various media outlets sometimes taking different angles on the very same news piece. For example:
We didn't purchase these companies, but did purchase a handful of REITs and other companies such as Harry Winston Diamond Corporation (HWD) that had similar performance. Of course, we also purchased American Oriental Bioengineering (AOB) and Bidz.com (BIDZ), which are flat to down from our average costs. Importantly, we acknowledge that we had no idea that the REITs and HWD would perform so strongly within six to nine months after our purchases -- we only believed we were buying cheap assets that no one wanted, with a margin of safety. We continue to hold the REITs and Harry Winston, as well as AOB and BIDZ.
- Short-term is uncertain but long-term is highly correlated to earnings power
- When evaluating businesses, ask these questions:
- Does the business have a strong financial position?
- What would happen if the business went away tomorrow? Would anyone care?
- Is management capable and motivated? Is disclosure full and adequate?
- Will the business be bigger, better, stronger if five years?
- Can the business be acquired with a margin of safety?
- Price is extremely important
On the last point, we like how the Fairholme Fund’s Bruce Berkowitz puts it: “Investing is all about what you pay and what you get”, which is a variation of advice from Ben Graham and Warren Buffett.
In our presentation, we highlighted three companies we believe meet our criteria: 1-800-Flowers.com (FLWS), Seaspan (SSW), and Weight Watchers (WTW):
- While 1-800-Flowers.com is highly discretionary, several durable competitive advantages support long-term cash generation and the business can be acquired with a current year free cash yield to equity of more than 20%. This valuation appears incredible and unlikely to last over as the capital light business model will enable management to use excess cash to repay debt, grow the business, repurchase shares, and potentially pay a dividend. Interestly, Provide Commerce (e.g. ProFlowers) was generating annual revenue of approximately $220 million and cash earnings of approximately $14 million (6% margin) when Liberty Media (LINTA) acquired the business for $477 million in fall 2005 (2.2x sales and 34x cash earnings). We estimate that Provide might be generating $300 million in annual sales today versus 1-800-Flowers.com's floral segment sales of around $380 million (our FY10 estimate). FLWS is currently offered by the market at an enterprise value and price to sales of approximately 0.20x.
- As per our prior posts, the container shipping sector faces significant excess supply, yet Seaspan’s 68 vessel fleet (43 operating, 25 to be delivered) are fully committed to long-term charters with COSCO of China and K-Line of Japan, which creates built-in growth over the next several years. We see the company as a means to participate in long-term global growth with diverse, creditworthy cash flow stream - high quality counterparties, 90% Chinese and Japanese. While the company does require some additional equity ($180 - $240 million per company) to finance new-builds, distributable cash flow is expected to triple to >$300 million per year with a full fleet in 2012 (perhaps $3.00 per fully diluted share, depending upon share count). During this period, annual revenue should more than double to $680 million with EBITDA growing to more than $500 million. So, we can purchase SSW today at approximately three to four times anticipated distributable cash flow in 2012.
- Consistently high margins/ROIC and excess cash flow indicate that Weight Watchers operates a high quality business model with durable franchise characteristics. Over the past ten years, revenue increased an estimated 3.2x to $1.41 billion, operating income increased an estimated 4.1x to $398 million (28.3% margin), and free cash flow increased an estimated 5.2x to $248 million (18% of revenue). We see potential for dividend increases over medium term as debt is reduced, which might lead to higher valuation multiples. Historic median multiples imply ~100% upside from current levels and, even acknowledging that growth may be less than prior years, discounted historic multiples still imply substantial upside. The business can be acquired today at an approximate 10% free cash flow yield. We first mentioned Weight Watchers last December.
Finally, let's throw in one more for good measure: under-followed micro-cap Sonic Foundry (SOFO) that, based on our research, offers the best Webcasting solution available and has a growing installed base of happy customers. Looking around today, Webcasting should only become more important across virtually all sectors. Sonic Foundry grew revenue 19% Y/Y in FY09 (end September) is poised to deliver accelerated revenue growth in FY10 with positive earnings and cash flow. Yet, the company is offered at approximately one times sales and possibly a mid-single digit P/E multiple on forward earnings for the year beginning this summer.
Let's close with one more point: the best time to purchase stocks is when no one wants them. For a variety of reasons (some obvious), no one wants 1-800-Flowers.com at present -- but that doesn't mean it's not a fantastic purchase at current levels. Seaspan and Weight Watchers are also out of favor, but are not quite as unloved as 1-800-Flowers today -- please see our blog here for more discussion. Briefly, while many funds can't or won't purchase FLWS at present with no apparent positive catalysts, we can afford to wait a few years if necessary to potentially make 100-200% on our investment today and not worry about plus (or minus) 10% next quarter.
Full Disclosure: Long SOFO, FLWS, SSW, WTW, AOB, BIDZ, HWD.