What A Croc

Classic case of cocky brand mgmt gone bad. But my bear case liquidation analysis blesses current $63mm EV even if the brand is worth zero. Barring major fraud, I think CROX will be bought.
The volatility in this stock over the past two weeks told us that something big was coming down the pike. In that regard CROX did not disappoint. I won’t drone on about sales weakness, downsizing or asset writedowns. Ron Snyder (CEO) summed it up with two of the weakest statements I have heard from a CEO – ever.

1) “After several years of rapid expansion, highlighted by triple digit sales and earnings growth, our business has slowed during 2008.” Gee, thanks for that insight Ron.

2) “Our performance was below expectations and continued to be impacted by the extremely challenging retail environments in the U.S. and Europe during the third quarter.” Are you kidding me??? How a company with the trend characteristics of Crocs has the audacity to mention a ‘weak retail environment’ simply blows me away.

Ok, I got that off my chest. Thanks for listening. The question from here is bigger than the quarter, the restructuring, etc… The reality is that after hours, this stock is trading at $1.13. With 82.8mm shares, and 31 million in net cash, we’re looking at a total enterprise value of $63mm.

The market is saying that the $312mm book value is nowhere close to being real. I’m inclined to agree. But assume the following…

1) All stated liabilities are fairly represented, but that they head 20% higher over 2 quarters as the business continues to erode.
2) All $40mm in intangibles are actually worthless.
3) PP&E is only worth 50% of stated value.
4) Only 75% of accounts receivable are collected.
5) Remaining inventory is liquidated at 50% off.
That all nets out to $50mm, or $0.60 per share in value. This equates about 53% of the market cap – which unfairly assumes that the brand goes away.

Don’t forget that Crocs is a brand. Do I wear them? No. I think they are hideous. But I am not the customer. Even customers that have moved on still remember the name – and the reality is that Crocs has had reasonable success extending into areas beyond the core product, and the name is worth something. At $63mm, we’re getting pretty dang close. Unless there is fraud, this thing will be bought.

PS: I think I just spent too much time analyzing a $100mm market cap company!

EAT – What is plaguing EAT today?

In October 2008, Moody's and Standard & Poor's placed Brinker's credit ratings under review for possible downgrade prompted by the company’s revised earnings expectations for fiscal 2009. Standard and Poor’s has since left EAT’s credit rating unchanged at BBB- (investment grade) with a stable outlook. Moody’s review, however, is ongoing and is focused on EAT’s ability to improve operating performance and debt protection metrics over the next few years.
As a result, EAT’s availability under its $150 million uncommitted credit facility declined to $50 million. If the current rating is confirmed, the availability under this facility will return to $150 million. However, if EAT’s rating is downgraded by Moody’s, the company’s uncommitted credit facilities totaling $250 million will no longer be available. EAT has said it is committed to maintaining its investment grade credit rating and is taking actions to ensure its current investment grade rating is reaffirmed. The review and subsequent outcome will not have any impact on EAT’s availability under a separate $300 million revolving credit facility.

As of last week, EAT expects to receive net cash proceeds of $125.5 million from the sale of Macaroni Grill in fiscal 2Q09, excluding fees and expenses associated with the closing of the transaction, and will use the proceeds to pay down debt. In addition, EAT is significantly reducing capital expenditures for fiscal 2009, eliminating nearly all growth capital spending in fiscal 2010 and is suspending its share repurchase program.

Time will tell…

SP500 Levels Into the Close...

It looks like we may very well get by here by the hair of our chiny chin chin... provided that the S&P500 does not close below its prior closing low of 848, our macro model will register this as a positive data point, on the margin. Everything that matters in our models happens on the margin.

There is an immediate term “Trade” setup here of down -1% and up +10% (risk/reward) in the SP500. That's as good as I have seen it in well over a year. See levels and chart below:

Buy "Trade" = 850
Sell "Trade" = 937

Buying into capitulatory selling is what capitalists do. What "they" levering up and buying them at this time last year is their problem, not yours. Be patient. Deploy your hard earned cash at a measured pace.

Early Look

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Eye On Oil: Updating Our Research Edge...

Since we sent out our last update detailed update on, Oil a good deal has changed. Most notably, the price of WTI (West Texas Intermediate) is now trading at just over $56 per barrel. I made the following point in our last update on October 18th, 2008:

“On the production side, while I totally buy the long term supply constraint argument, in the short term and this is very simplistic, if OPEC has to cut production to maintain price than scarcity value should not be priced into Oil anymore (I think that was part of the argument that people were making when Oil was on its way to $140 i.e. there is a premium above marginal cost for scarcity), thus Oil should trend towards its marginal cost . . .$60 / $65?”

Since I wrote about the dangers of narrative fallacies this weekend, I’m not going to pretend that I called the decline in oil we’ve seen over the last few weeks, but I did want to highlight the point above because it is very important in understating the context of how Oil has traded.

Oil has traded down despite what are, ostensibly, bullish data points. Specifically, OPEC announced a 1.5MM barrel per day emergency production cut a week after my post on October 24th. Obviously this has done little to support the price of Oil as the commodity is down roughly another 10% since then. What this tells me is that the concept of Peak Oil, at least in the short term, is finally getting priced out of the commodity. And that, on the margin, suggests to me that the Oil bottoming may be beginning. Remember, bottoms are processes, not points.

On the demand side, despite consumer weakness, there is no doubt that the dramatic declines in gasoline prices we have seen in the U.S. and around the world will have, on the margin, a positive impact on demand. At a sub $2.40 per gallon price, gasoline is down by more than $1.70 from its July “Peak Oil” peak. Eventually this will have a positive impact on y-o-y demand comparisons, even if it is a quarter or two away.

The other key point I made above is that the marginal cost of production for Oil, according to many oil economists, is in the $60 per barrel range. Obviously this is a vast simplification and is subject to grades of oil and services costs, but, once again, on the margin this price level is important. At this price, many projects become less economic and at sustained prices below $60 per barrel we will see some mothballing of exploration and development projects. The excerpt below from an article in the Houston Chronicle today highlights these points:

“Oil prices closed below $60 a barrel, a level widely considered to be near the break-even point for multibillion-dollar deep-water projects that have been a key driver of Houston’s energy economy in recent years. If prices go lower still, oil companies could be forced to re-evaluate and possibly postpone deep-water projects, just as they have already done with less-costly land and shallow-water drilling plans, analysts said. At $50, they probably start canceling projects or slowing projects up,” said Eric Smith, associate director of the Tulane Energy Institute in New Orleans.”

We are not ready to call a bottom just yet, but after a ~20% decline since our last update and a 1.5 barrel production cut from OPEC, we are certainly getting interested.

Daryl G. Jones
Managing Director

Eye On US Healthcare: Mad Max?

Fire up the Thunder dome. The Democrats are in the house and the Max Baucus Plan is in motion – conference call just ended; here are our head of healthcare, Tom Tobin’s, immediate takeaways:

The scariest part of the plan is the Health Exchange, but that won’t happen for 3 years.

The idea is to push everyone into a market to purchase insurance. The question is the margin for those products. 50M additional lives is a significant boost even at 10% gross margins.

In the meantime, Medicare expands to cover younger Americans and SCHIP expands. Medicare Advantage cuts are a sure thing. This wont kill the companies and has been quantified.

No change to employer system until Exchange is created. So no near term risk of further disenrollment or margin pressure from employers anticipating a government plan. This is positive for UNH and AET.

Baucus expects to enact legislation 1H09, but I got the distinct impression he is acting on his own. This may be a problem that delays things.

CBO analysis is likely more favorable this time around as opposed to 1992.

“Devil is in the details” was the key quote.

Baucus expects the plan to lose money initially, but save later. This is the key to the CBO score and pay-go.
If there is any conclusion, device manufacturers are most at risk.

Baucus wants to create a comparative institute to score effectiveness of therapies and allow hospitals to partner with physicians to participate in cost savings initiatives. He also want to ban collaboration with docs and industry. This seems like a recipe for unit pricing declines.

This is perversely positive for R&D, the only engine to generate new products.

Thomas Tobin
Managing Director

Eye On Leadership: Jaime Dimon

This is definitely one of the quotes of the day that lines up most succinctly with what we have been saying this week - "we're not running the company as if we're in a Great Depression" (Jaime Dimon, CEO of JPM).

Nice call Mr. Dimon - we're on board with you there. People are freaking out about 2009, and you're providing some leadership to calm the fear that some investors should have had 12 months ago.

We are not going into a Great Depression. The only depression I see dominating New York's groupthink is in the bank accounts of the levered longs.

Keith McCullough

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