M&F Worldwide Hits New Lows: What You Need to Know

Includes: LO, MFW, REV
by: The Keating Letter

As part of my daily report on new 52 week lows, I recently came across M&F Worldwide (NYSE:MFW). They hit another new 52 week low of $21.36 on January 21. Ironically enough, Barron’s had a piece on them in the January 24 edition. After reading this article, I encourage you to take a look at that article: Cheap Stock… With One Big Catch.

While the Barron’s piece had some nice background information, and touched on some of the reasons for the recent drop in price, it generally overlooked the two immediate reasons for the drop. The first is the government debate about banning menthol cigarettes. The obvious stock under attack is Lorillard (NYSE:LO), the leading menthol cigarette manufacturer. It’s been hit 10% since the beginning of the year. Not a happy return over a three week period when the overall market has been up. The other reason is a recent acquisition which took a big chunk of their cash. However, even with this, M&F is generating a tremendous amount of free cash relative to its market cap.

Let’s go into an overview of the company before discussing the valuation. M&F is a holding company with two subsidiaries:

Harland Clarke Holdings contains Harland Clarke, which makes checks and other related forms, Harland Financial Services, which provides technology services to financial institutions, and Scantron. I’m sure we all remember using Scantron tests while in school. Scantron recently purchased GlobalScholar, a privately held education technology company, for $140 million. This is the transaction, which while positive in the long-term, is causing concern in the short term because of the chunk of cash laid out for the purchase.

Mafco is the second subsidiary and makes licorice extract. 67% of their sales go to cigarette companies to make menthol cigarettes. It should be noted that this is worldwide, though, and even if menthol cigarettes are banned in the U.S., which is very, very unlikely, you’ve still got international sales to tobacco companies and 33% of sales going to non-tobacco-related products. While cigarette sales are generally dropping in developed countries, they are rising in the developing world. Also, considering this part of the company makes up less than 10% of annual revenue, it should not be much of a concern.

Ronald Perelman, of Revlon (NYSE:REV) fame, is the chairman and controls 43% of the shares. Renowned small cap value investor, Michael Price of MFP Investors, owns .5% of the company.

The valuation here is crazy. At today’s price, the market cap is about $415 million, yet the company generates $200 million of free cash flow annually. Because of amortization, their net income figures are intentionally depressed, but will still be more than $6 in 2010 after reporting more than $6 in 2009. They’ve already reported $4.81 in the first nine months, and estimates for Q4 are $1.55. That gives you a PE of 3.37. Plus, FCF is half of the market cap. Even with most of their revenue coming from a declining business, this is pretty cheap.

Barron’s thinks the licorice business alone could sell for $10/share. Yes, its check business is in trouble over the long term, but the GlobalScholar purchase shows that the company can adapt and move away from old businesses and into new. They wouldn’t have made that purchase with all cash if they had any concerns about the debt load. Given their cash generation, I agree with them.

M&F Worldwide does have a little bit of a sordid history. You can look up Perelman’s self-dealings with Panavision, but that was a decade ago and obviously didn’t affect the stock price when it was nearly $70 in 2007.

In short, can they handle their debt load? Yes. Will the check business disappear tomorrow? No. If you believe those two things, it’s very difficult to defend the current stock price.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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