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China Needs To Avert A Gold Medal Hangover

It’s easy to get excited about a 23% boost in China’s retail sales for the month of July, the highest rate since February 1996. But let’s not forget that despite China’s growth profile it still only accounts for 17% of Asian GDP (and 5% of world GDP). While we’re seeing Olympic-fueled growth rates out of China, the rest of Asia is hitting the skids.

South Korea’s three largest department stores just posted the slowest growth rate in 5 months -- with July’s 5.9% at less than half the prior month’s rate. Hong Kong’s GDP rose 4.2% (down from 7.3%) -- the slowest rate in 5 years due to slower consumption and exports. Perhaps the biggest nugget is Japan, which posted a 12.9% yy decline in department store sales of clothing. This is the second weakest reading on record in recent history (-16.5% in March 1998), and the weakest 3 month trend in at least 30 years.

What happens if China cools? Let’s hope the Olympic hangover is a short one.

LDG - California Dreaming

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?

PAYING UP FOR LIQUIDITY 2: AMERICAN EXPRESS

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

Early Look

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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

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…

KM
(charts courtesy of StockCharts.com)

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