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On Friday American Express Credit Corp. floated $2 Billion in 5 year paper with a yield of 7.34% -almost 20 basis points higher than the current yield for corporates on the lowest investment grade rung.

There are still buyers out there, but only for issuers who are willing to pay up.

Andrew Barber -Director

YUM – Struggling!

From my Partner Keith McCullough - Very bad under 37.56 now; stock sells off on big volume, has up days on low volume - negative Trend developing

LDG, Part III: Penney's Thoughts on Ackman's Real Estate Dreams...

During my career as an analyst and an investment banker, I spent a lot of time looking at real estate transactions for a number of different companies. In most cases, the business model was better off owning the real estate, as it provided a level of stability to earnings. I will go as far to say that selling a company’s real estate portfolio is about as effective in creating shareholder value as an activist shareholder telling a company to use leverage to buy back stock!

Even during the bull market for real estate, monetizing a company’s real estate portfolio did not maximize value for shareholders. Today, given the secular bear market in real estate (and financials); I can’t imagine that an activist would still peruse a real estate strategy as a means of creating shareholder value. It is as if someone is still holding on to a dream. I guess if Bill Ackman can prove to the world that LDG’s real estate can add incremental value, it will validate his other consumer holdings. There could be a lot riding on this strategy for Ackman!

In short, selling a company’s undervalued real estate creates an enormous tax burden, which limits the cash available to maximize value for shareholders. I truly believe that Bill Ackman knows this, and I have yet to see a structure from him that would get around the tax issue completely.

Here is a list of companies with significant real estate holdings that I have followed that have had activists and others try to create value:

1. MCD – The McREIT has been a dream for years!
2. WEN – selling the real estate was part of the “grand” plan, but it never materialized.
3. CBRL – Nelson Peltz tried, but the bankers decided a leverage recap was better. The stock is significantly below where they did the recap.
4. RYAN - went private, did a sale-leaseback and now the company is bankrupt. The lender is going to end up owning the company.
5. OSI – owned 1/3 of its R.E before it went private. OSI did a massive sale-leaseback and now the company is teetering on the verge of bankruptcy.
6. BOBE - lots of speculation but nothing ever materialized. The margins in the business cannot support incremental leases. (i.e. RYAN)
7. DRI – The single largest casual dining restaurant company with over 1,100 pieces of property (and it sits in a REIT today). The real estate portfolio is a safety net for the company in difficult times. Management is on the record saying that the R.E is worth more as a part of DRI.

Two other high profile companies where real estate was the focus are SHLD and TGT. Both are key holdings for Pershing Square. The Eddie/Sears story was real estate based, and nothing ever materialized - thankfully for SHLD. SHLD is in trouble operationally! Can you imagine how bad things would be if they had sold off the real estate and had all that incremental leverage? I would bet money that SHLD would have already filed chapter 11 if they did a sale-leaseback two years ago. The same is true for LDG! LDG’s EBIT margins are 3.3% (6.4% for CVS and 5.8% for WAG). With 3.3% EBIT margins, the business can’t support doing a sale-leaseback on 142 stores.

The speculation is that the real estate is worth $1.0 billion, or $7mm per store. Seems a tad aggressive! A close look at the 10K will show that they own the land and building on 28% of the store base or 142 stores (I have seen numbers as high as 40 %). According to a highly regarded supermarket analyst, Publix recently paid $10 million/store for some Albertsons stores in Florida, or about $200 per sq ft. At $200/sq ft that would value LDG stores at $595 million. I know that LDGs real estate is in California, but who is going to pay a premium for California real estate today?

None of this matters because operationally, LDG’s business can’t support incremental leverage.

Howard Penney
Managing Director
Research Edge, LLC

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LDG, Part II: Ackman Pushing For a Higher Price?

With both the Financial Times and the Wall Street Journal running stories in the last 72 hours on Bill Ackman’s alleged behind the scenes financial maneuverings with regards to Pershing’s levered investment in Longs Drugs (LDG), I guess he wants us all to pay attention. After grinding through his 13D filings and the timing of his purchases therein (see portal posting from 8/15), I am officially all in for this show.

The FT is citing someone “close to the matter” and the WSJ a “person familiar with the situation”. This kind of super secret rumor whispering is not unlike that which investors have had to endure with both of Ackman’s latest unsuccessful attempts at pushing his own book with both Border’s Group (BGP) and Target (TGT). As reference points, charts for both TGT and BGP are below.

It would be one thing if I was a reporter, it’s entirely another in this case however because I have invested in all 3 of the aforementioned companies for multi-billion dollar hedge funds in the past. I have had multiple one on one meetings with all of the senior management teams of the these companies – I know the assets and the players who analyze them.

Interestingly, when my partner and I drove up to Long’s Drugs headquarters in California for the first time in 2004, the stock was almost -75% lower than where Ackman is allegedly suggesting is not high enough today. The stores are now older, and the economy weaker.

At, $71.99/share, Longs (LDG) is trading at a premium to the proposed CVS takeout price. Why is that? Who leaks these creative “financial maximizations of shareholder value” into the market place? Who gets paid the most if it all comes to fruition? Who invests other people’s money this way?

These are all critical questions. So is addressing the two bull cases that someone out there with a levered financial incentive wants you to consider – so let’s put the analytical pants on and take a walk down that path.

1. Walgreens (WAG) coming in with a higher bid than CVS’s

2. Blackstone (BX) signing off on Ackman’s alleged, and magically creative, real estate idea

I don’t think either are reasonable options for reasonable investors to consider in economic times like this.

On the Walgreens side of the ledger there are 3 reasons I can start you off with: 1. Valuation – the implied valuation for LDG above deal price approaches 10.5x cash flow, and WAG trades for 9x (ttm) EBITDA – no way WAG pays this price, 2. CA store overlap and antitrust approval is far too cumbersome, and 3. the core Longs Drug store formats are round holes compared to WAG’s proverbial square pegs – store conversions make no sense; they would dilute WAG’s unit level productivity and return metrics.

On the Blackstone front, we are still speaking with our contacts this weekend in order to get more insight. The bottom line however is that Ackman has retained Blackstone in the past. This is not new. This is what he does. I have seen this movie before. Be sure that he pays Blackstone plenty of money to “think” about creative ways to get him out of his buying Target (TGT) at both an economic cycle top, and leverage cycle top.

CVS shareholders better be following the bouncing ball very closely here.

Stay tuned…

(charts courtesy of StockCharts.com)


With another summer weekend behind us, it’s back to the grind here this morning. All things considered, US futures look pretty good relative to what they could look like. I think there is still some gas left in the tank here on the bullish side of the pain “Trade”, which remains higher.

With the US Dollar finding its footing and commodity driven inflation coming in hot, it has been virtually impossible for the objective mind to remain ultra bearish in the immediate term. For the intermediate term “Trend” in the S&P 500 to turn positive however, I’ll need to see a close above the 1330 line.

As US earnings season winds down, we’re moving back to macro time, and I’ll do my best to proactively highlight where the masses might be focused. The two most important macro dates on your calendar for this week will be tomorrow (housing starts and PPI for July) and Friday, when Ben Bernanke will gather his politicized Fed for a powwow in Jackson Hole.

On the inflation front, it would be hard to see a more elevated headline PPI than we saw in last week’s CPI, and it would be even harder to explain why 2 year US Treasury yields have stopped going up despite as much. The most logical conclusion that I can surmise is that Bernanke is going to pander to the bailout populous on Friday, and continue with his dovish rhetoric. This, of course, keeps the easy money Fed card in play, and leaves room for levered long investors to continue to hope that the US stock market “bottom is in”.

In the end, Bernanke not tightening the screws on cost of capital is going to continue to equate to widening credit spreads and mounting systemic risk in the US Financial system. The longer he keeps undisciplined players on life support, the more protracted the American economic downturn will be. I am certainly not the only one with this view at this point. Bernanke’s recently “retired” Fed teammate, Charles Plosser, is on the record in a Bloomberg interview this morning saying, ``there is some hard thinking that needs to be done…the Fed has a terrific reputation as a credible institution. We have to be cautious not to undertake things that put that credibility at risk…''

From Russia to Jackson hole, credibility is what this brave new ‘You Tube’ world is looking for. Credibility, transparency, and accountability – people get that, particularly when you show it to them. People aren’t as dumb as Wall Street would like to think. The power of real time information transfer is shifting. The leverage is being put back into the hands of what has long been considered the feudal system of financial wherewithal – Main Street. If you want to predict how humans behave, follow where their money is.

In Asian trading this morning we are seeing the Chinese locals follow one another’s money out the door. China got hammered for another -5.3% down move overnight, taking the Shanghai Composite Index down to 2319 – that’s a -15% drop since the Olympics began. Find me a bird’s nest to crawl into.

Stocks in Hong Kong reacted negatively to this decline, closing down another -1.1%. Since July 23rd, the Hang Seng index has lost -10% of its value in the face of the S&P 500 moving +1% over the same duration. This is a major league negative divergence. It is telling you that global growth is slowing, big time. This certainly explains why commodities have corrected over -20% in a month, and probably explains why US Treasuries are breaking out as well.

As the US market “Trade” continues upward into the tail end of its latest run-up, I’ll likely be moving up to 90% cash.

Best of luck out there this week,

‘The Question’, and a Scary Answer

We’re kicking off a new product at Research Edge called “The Question,” whereby our analysts pick one key issue each week and take industry leaders to task. We won’t take company tag-lines at face value.

I think there are few issues more important to this industry right now than the impact of FX on the P&L – not only because the multi-year slide in the dollar has been glossed over by many in this business, but also because of the violent reversal in the US$/Euro over the past 2 weeks.

I am 100% convinced that within 2 quarters, we are going to see a meaningful bifurcation between the winners and losers in a different FX climate. The winners have invested capital in their respective models while the dollar slid – companies like Ralph Lauren, Timberland, Liz Claiborne and Nike. Others printed way too much margin – such as Warnaco, Guess, Skechers, and Adidas.

‘The Question’: We asked 13 branded apparel/footwear companies the following question. “Philosophically, please walk me through your approach to managing FX. How do you alter levels of investment to take advantage of (or offset) fluctuations in the FX environment.” We were extremely consistent with our questioning, and did not lead the witness in any situation.

‘The Answer’: Weak -- all around. I expected this from the weaker players. But what surprised me most is that most of the better companies that I think have appropriately reinvested FX benefit (instead of passing it all through in the form higher margins) were unable to articulate any real strategy around the issue.

The purpose of “The Question” is to get to the bottom of key issues of investment significance, and to call out those companies that are particular standouts (+ and -). You remember back in high school when occasionally the whole class would get a detention slip instead of just the class clown? That’s what we’ve got here. No one is getting out of detention on this one.

Plan B – Math: When the results of our discussions appeared to be coming in rather grim, we started to crank through some good ol’ fashioned math. (Note, we’d have done the math anyway). We took all 13 companies and looked at company-reported FX impact to revenue, and compared to the incremental change in EBIT. In effect, we looked at what percent of the change in FX passed through to aggregate company results. The results were startling, and are shown in aggregate for the group below.

a) From early 2006 through 3Q07, the incremental FX margin averaged 100% while the Euro went from 1.26 to 1.44. No joke.
b) Starting 4Q07, the incremental margin dropped to about 15% despite another 0.14 boost in the Euro. This is the level we SHOULD see. In a perfect world, the companies would reinvest excess FX benefit in a way that keeps margins relatively steady. When FX helps, reinvest the benefit. When FX reverses, there’s a bigger base in place to help grow, and worst case to trim costs out of.
c) Unfortunately, it is not a perfect world for these companies. The fact that incremental margins came down so much when FX dictated otherwise tells me that real margins on the base business were down far more than most people realize.
d) If currency stays where it is today, we’ll be looking at negative 5-10% FX comps one quarter out. I maintain my view that margins are still coming down 2-3 points in this business over 2-3 years. FX might make this happen sooner than later. Clear the decks!

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