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noahfarb
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I am a 27 year old investor. I have experience purchasing distressed real estate, particularly finished residential lots in Northern California. I'm on here to learn from other investor's ideas and to have a forum to write down my investment ideas and receive feedback. I don't hold on to any of... More
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Golden Bear Capital
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  • CCME Fraud Debate- Teeth in the Starr deal
    The past week we have seen an absolute assault on Chinese inter-city bus advertiser, China Media Express (OTCPK:CCME), from bloggers alleging that the entire company is a massive fraud. Many individuals on the long side have made very compelling arguments dispelling the criticism. However, I personally do not have the knowledge and understanding of Chinese business practices, language, and culture to adequately weigh in on the such arguments.

    There is another way to look at the issue, though, without getting into the he said she said game between the shorts and longs, and that is to look at the incentives. Since incentives for short seller are easy to understand, let's look at the management's incentive. Generally speaking, corporate frauds tend to develop by attempting to hide the losses of a previously legit business. I have not seen many that were frauds right off the bat, and I would imagine the management of a company that is fraudulent from inception would take the cash and run first chance they get. CCME has not been around all that long, and it would seem that if they were a fraud, that they always have been. 

    This leads me to the 30MM investment made by Starr International in Jan. 2010. Many have argued that Starr got too sweet a deal. For reasons that are not the point of this post, I disagree with this argument.  But what stands out to me with respect to the issue of the veracity of the company's reported earnings, is that the deal with Starr has some serious teeth in it. Take a minute to review the following paragraph from the 10k:


    "In addition, for so long as Starr owns at least 3% of the Company’s Common Stock on a fully-diluted and as-converted basis, Starr will have the right to purchase a pro rata portion of any additional shares of capital stock proposed to be issued by the Company, and will have the right to join certain stockholders in their sale of capital stock of the Company on a pro rata basis, in each case in proportion to Starr’s then current percentage of ownership of the issued and outstanding shares of Common Stock, on a fully diluted, as-converted basis. As long as Starr owns at least 3% of the issued and outstanding shares of Common Stock, on a fully diluted, as-converted basis, it will also have the right to require certain stockholders to purchase its Preferred Stock and the Common Stock held by Starr or issued upon the conversion of Preferred Stock or exercise of the Purchased Warrants upon the occurrence of the Company’s failure to achieve audited consolidated net profits (“ACNP”) for 2009, 2010 or 2011 are less than $42 million, $55 million and $70 million, respectively (each, a “Profits Target”) or to fulfill certain of its obligations under the Purchase Agreement. The Performance Adjustment Amount payable in any of 2009, 2010 or 2011 will be a fraction of $343,462,957 which is proportionate to the amount by which the Company’s ACNP in such year falls short of the then applicable Profits Target. The Performance Adjustment Amounts will be payable in cash or stock, but only to the extent such stock, together with the shares of Common Stock acquired or acquirable as a result of Starr’s ownership of the Preferred Stock, the Purchased Warrants and the Transferred Shares, will not exceed 19.9% of the total number of shares of Common Stock of the Company issued and outstanding as of the date of the Purchase Agreement. In the event that the stockholders subject to the obligation to purchase Starr’s shares under the put right or to obligations under the performance-based adjustment provisions do not comply therewith, Starr will have the right to require such stockholders to sell up to all of the Companys’ capital stock directly or indirectly held by them to a third party pursuant to a managed sale process."


    Essentially what this paragraph describes is a put option agreement directly with the company's management- presumably CEO Cheng Zheng- that is triggered in the event specified performance measures are not achieved. Needless to say, the discovery of fraud would trigger the put option. I don't feel like going through the math on it here, but if you'd like to work it out on your own you will find that if fraud were uncovered, this put option would likely wipe out the CEO entirely. An additional part of the deal, I should note, gave Starr a seat on the board and allowed Starr to pick the auditor-Delloitte Hong Kong.

    So back to incentives. It takes a pretty confident CEO to enter into this type of transaction. If it were a fraud, this would require him to keep it going into 2012 with substantially increased scrutiny, and with serious financial consequences if he fails. In fact, this would be about the dumbest agreement I could imagine a fraudulent CEO entering into. 

    For many reasons I just don't see how the short argument adds up. However, since I have yet to see a discussion of this part of the Starr deal, I thought it would be worthwhile to post here. I welcome your comments.


    Disclosure: Long CCME

    Tags: CCME
    Feb 09 8:26 PM | Link | 26 Comments
  • Is Gordmans Still Underpriced?

    Coming public in August 2010 at $10 per share, discount retailer, Gordmans Stores Inc. (NYSE: GMAN), has rewarded its shareholders handsomely. In now trades near $16 per share. But should owners of the stock book their profits now?

    The stock is priced similarly to competitors Ross, TJX, and Target. It is, however, any times smaller. This can be both an advantage, as far as having greater growth potential, and a disadvantage, as smaller business can be more fickle than their larger competitors. So what’s the story at Gordmans? Let’s take a look.

    Business/History:

    Gordmans is a discount retailer, featuring department store brands at up to 60% off. Merchandise includes apparel, accessories, footwear, and home fashions. They operate 68 stores in 16 Midwestern states. GMAN differs from retailers such as WalMart and Target by providing specialty and department store brands. Their closest peers are off-price retailers such as Ross and T.J. Maxx. GMAN stores are larger, 50,000 sq. ft. prototype, allowing them to provide a broader assortment of merchandise. They place an emphasis on store organization and layout, and also use a different pricing which they believe strengthens customer and vendor relationships. As described in the prospectus:

    Many other retailers, including many of our competitors, agree to pay a higher initial price to their vendors, but then seek to offset that higher price by demanding various reimbursements and discounts. Such retailers carry their products at a higher ticketed retail price, but then sell the majority of their merchandise at a discount under various promotions and sales. Thus, while our all-in cost of merchandise, and the ultimate sale price to our customers, may be similar to that of our competitors, we offer our vendors and customers greater certainty of pricing, which we believe is attractive to both vendors and customers. Finally, opportunistic merchandise procurement strategies, which in conjunction with everyday low prices define the off-price segment of the retailing industry, further enhance our value proposition.

    Gordmans evolved from a chain of ½ Price stores that emerged from bankruptcy in 1993. Current CEO Jeff Gorman took the reins in 1996, at a crucial juncture in the business. At the time there were 21 stores producing 220MM in sales, but the business was in need of numerous repairs. Gordman added to the management team, addressed pricing strategies and customer service policies, and changed the name of the business to “Gordmans”.

    Entering 2000 with 32 stores, Gordmans began rapid business expansion. There were 40 stores by 2002, and between 2004 and 2008, the business grew from 44 stores in 12 states to 65 stores in 16 states. In 2008, Gordmans was acquired by Sun Capital Partners Inc. for 56MM. It emerged as a public company in August, 2010 through an IPO. Sun Capital Partners still owns 70% of the firm, so it is thus a controlled company.

    The net proceeds from the IPO were roughly 30MM, this was used to pay down borrowings (18.2MM), to pay Sun Capital a consulting agreement termination fee (8.1MM), to pay bonus to certain executives (2.5MM), and to replenish working capital. A special dividend of 20MM was paid prior to the IPO, which was paid using borrowing (repaid by the IPO) and working capital.

    The company, as of October 2010, consists of 68 stores in 16 states. Sales for the year ended Jan. 2010 were 458MM, and it appears FY2010 sales will be in the ballpark of 500MM. While owned by Sun Capital, the firm took several measures to improve business strategy, corporate infrastructure and operating margins, and to position for large scale growth.

    Management believes it can continue to drive same store sales and margins, as well as expand the store base at a rate of 10% per year for the next several years. 60 markets in 16 states within a 750 mile radius of the company headquarters in Omaha, Ne. have been targeted for openings. Management believes these markets can support an additional 150 stores.  Since third quarter 2009, there have been three new store openings.

    Their distribution center has the capacity to support an additional 110 stores, and the company is well positioned to leverage its corporate infrastructure. Management’s stated goals are 20% annual net income growth, 10% annual store growth, 3-5% annual comp growth, and achieving 8% operating margins (a 230 bp increase over 2009).

    Financials:

    The balance sheet and income statement are quite clean and easy to read. This is a relief for investors, but also indicating less likelihood of stock mispricing.

    As of Oct. 30, 2010 the company had 29MM working capital, with a current ratio of about 1.3. They carry little to no debt on the balance sheet.

    Net income for the year ended 1/30/2010 was approximately 15.8MM. The company just posted a blowout Q3 2010 driven by 6% comparable store revenue growth. Net income for the nine months ended 10/30/2010 was 7.2MM, but excluding the one-time pre-tax charges relating to the IPO, net income for the nine-month period was 14.7MM ($0.87 per share). Management revised Q4 2010 guidance upward to 7.2-8.1MM ($0.37-$0.42) for the quarter. Using the low end of management’s guidance, FY 2010 income will be $1.24 per share excluding IPO related charges. Applying a P/E multiple of 15 would give a share price of $18.60.

    The stock is thinly traded. There are 18.9 mm shares outstanding, but just a 5.9 mm float, with average volume of about 50k per day. There’s a 3.2% short interest.

    Management:

    Management’s compensation is based mostly on performance, with a substantial long-term incentive structure. There have been many insider purchases since the IPO, with the most recent insider purchases at $17.50 per share. These purchases, however, consisted of a total of just 2,500 shares amongst three directors. The most significant insider purchase was by CEO Jeffrey Gordman, for 36,000 shares at $10 per share shortly after the IPO.

    Gordman’s track record as CEO has been very strong, and management is heavily incentivized by the success of their growth strategy.

    Why might the security be mispriced in the market?

    ·         Recent retail industry IPO- August 2010. Raised less funds, and at a lower price than expected.

    ·         Small market cap (300MM) decreases institutional demand.

    ·         Equity sponsor, Sun Capital Partners Inc., who bought the company in 2006, owns 70% of outstanding shares.

    ·         Last two quarterly reports were adversely affected by non-recurring expenses from the IPO.

    ·         Limited information available on operating history.

    My Opinion:

    The market is mispricing the growth opportunity. If you have shopped at other discount retailers such as Ross or T.J. Maxx, you can easily see that there is significant room for improvement, especially relating to the customer experience. Making this improvement in off-price retail is exactly Gordmans’ business model- to provide a more customer friendly discount department store. With a proven concept across multiple states and regions, and ample cash flow to fund growth organically, management’s objective of 10% per year store growth should be sustainable for several years. There is also room for growth in comparable store sales. They have a solid balance sheet with little to no debt, and an untapped 78MM line of credit. Management has a strong track record, and has spent the past few years focused on improving corporate and store operating efficiency rather than store growth. Once the market catches on to the earnings strength and reliable growth, a higher earnings multiple should be assigned to the stock.

     



    Disclosure: I am long GMAN.
    Tags: GMAN
    Jan 20 7:39 PM | Link | Comment!
  • RAIT Financial Trust (RAS)- big margin of safety
    The company's business consists of the following:

    1. 1.3B loan book- consists of match-funded, non-recourse CDOs. The interest margin from the loan book contributed approximately 40% of revenue for Q3 10.

    2. 824MM real estate portfolio- 67% multi-family, 25% office, 5% retail, 3% other. Avg. occupancy of portfolio is 78.5%. Rental income contributes about 50% of revenues.

    3. Other debt securities- funded with non-recourse debt. Primarily contributes fee income.

    4. Property management and broker/dealer services- fee income.

    The company got itself in trouble with investments in residential mortgage backed securities. It has since rid itself of any exposure to residential mbs. The company is paying down it's recourse debt and focussing on its core business of commercial real estate lending, and owning and managing commercial real estate. 

    The stock has been volatile, and was hammered following the Oct. 22 earnings call. Part of the concern is the 143MM senior convertible notes that are due (the holder has an option to convert or call the balance) April, 2012. This will either need to be paid off or refinanced. The total recourse debt is approx. 330MM.

    Since the company is going through a transformation, it is not the easiest to analyze. I have applied a very simplified technique that I think is valid. It's basically a liquidation value. Please share your thoughts.

    Since the loan book and their investments in TruPS and other debt securities are encumbered by only non-recourse debt, let's just assume those fail, and that nothing comes from them. (I actually believe these assets have some value in excess of the debt.) This will wipe out the restricted cash on the balance sheet, and almost all of non-recourse debt.

    What is left?

    Assets:
    824MM real estate portfolio
    25MM cash
    35MM NOL (tax asset)
    884MM 

    Less:
    64MM Non-Recourse debt on real estate
    330MM Recourse debt (143MM due April 2012)
    394MM

    Subtract 394MM from 884MM, and you have 490MM left for the holders of RAIT's common equity. The market cap today is about 180MM. 

    Now that is a margin of safety if I've ever seen one. Additionally, recent leasing activity has been very strong (we will see the economic benefits in Q4 10 and Q1 11), management bought back a bunch of stock earlier in the year, and they seem to be making all the right decisions toward reviving their business. I'm looking for a big 2011 for shares of RAIT Financial Trust.




    Disclosure: Long RAS
    Tags: RAS
    Nov 09 2:55 PM | Link | Comment!
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