MRT Gains 31% on Friday Following Shareholder Plug on CNBC

On Thursday after market close, Rady Asset Management CEO, Harry Rady, suggested Morton's Restaurant Group (MRT), worth approximately $60 million at the time, was a "4 bagger" because it was priced at 40% of book value and had $1.50 of earnings power. At the time the stock was trading at $3.69 per share and Mr. Rady disclosed that he held a position in the stock.

The following day, the stock soared 30.9% and closed at $4.83 on a day when 609,000 were traded, approximately 10x the normal average daily volume. In the two days since, the stock has traded with double the normal daily volume.

It is natural to be optimistic about the value and prospects of the stocks you own; however, we think the statements Mr. Rady made were misleading or false. First of all, the claim that it was trading at 40% of book value was just untrue. As of that day, the last reported balance sheet (Q2 ended 3/31/09) reported assets of $245.9 million, liabilities of $164.2 million, and equity of $81.7 million. As a result, MRT was trading at 75% of book value, not the 40% Mr Rady stated. In addition, goodwill and intangibles accounted for $92.8 million of assets at the time. Since they reported a goodwill impairment in FY 08 and have reported very weak cash flow numbers in recent periods (cash flow being a key input in impairment testing), we believe goodwill and intangibles should be excluded from a measure of book value. As of last Thursday, tangible book value was negative $11.1 million, not exactly a bargain in our opinion.

Second, Mr. Rady stated that the Company had $1.50 of earnings power. In FY 06, the Company reported non-GAAP EPS of $0.86, which was the best of the last four to five years. Given that the MRT success is dependent upon corporate expense accounts that are likely to be constrained for some time, we think his call for $1.50 earnings power is overly optimistic and would be interested to see the assumptions and time horizon behind the bullish call.

Investors should be doing their homework and not buying blindly, but anytime you get such a bullish call on a relatively illiquid small market cap stock, there is bound to be a significant pop just driven by the increased attention. Looking at the Top 10 holders, we do not see Rady Asset Management, but there are interlocking relationships with two of the top 10 holders, American Assets Investment Management, LLC and Insurance Company of the West (Mr. Rady's father founded American and is Chairman of the Insurance Company of the West). Together, the two investment firms own over 500,000 shares of the Company. The optimist in me thinks these two firms added to their positions given that the stock remained undervalued relative to the younger Mr. Rady's expectations, but the pessimist in me can't help but note that a significant share price move and heavy volume trading would provide excellent cover to reduce one's holdings. I guess we'll have to wait until 13F's are disclosed to know for sure.

On Friday, MRT filed its Q2 10Q, which provided a balance sheet and cash flow statement (not provided in earnings releases). According to its filings, the Company has used $13.4 million in free cash flow in H1 09. It currently has $3.7 million in available borrowing on its senior credit facility of $75 million. At the end of the year, the revolving credit facility is reduced to $70 million. Given the cash burn and liquidity constraints, we are concerned MRT may need to raise equity. This recent share price pop may provide a great opportunity to do so.

Disclosure: short MRT