Dutch Tender

I am a New York based investment advisor. I may have a position in the companies I write about or my clients may have a position. I may be buying or selling the companies I write about for myself, or on behalf of clients. Nothing I write about is a recommendation to buy or sell anything. It is opinion and information and should not be used as the sole information source for buying or selling any securities I write about. But I hope you will still read here. ;-)

1.19.2008

Tracking Liberty's John Malone

Despite all of the value creation going on beneath the surface at John Malone's Liberty Media, it's two tracking stocks, Liberty Capital (lcapa) and Liberty Interactive (linta), on a market cap basis, now actually trade about 10% below the highly depressed, pre-spin levels of May 2006. 

An experienced "tape watcher" might notice that linta especially, was being unrepentantly liquidated over the last few weeks, (it's down about 25% ytd) perhaps by Oakmark, Weitz, any number of other value managers, or troubled hedge funds. Many value shops are seeing their highest rate of redemptions since the dark days of late 1999 and early 2000.

Hedge funds that go long and short have seen many of their pair trades blow up. These investors are now in the process of creating liquidity for their funds, and may sell a perfectly fine holding simply because it is more liquid than some of their other holdings. Or it could be that selling linta is the best of a bunch of terrible options for an investor in distress. All of this chaotic, forced selling, has caused the shares of many attractive companies, including linta, to careen lower further than and faster than S&P 500 index, for no fundamentally sound reason.

During this credit crunch and crisis in confidence, investors have been shunning just about anything consumer related, but especially cable and retail properties. This disdain hits Liberty Interactive doubly hard since it's primary asset, the 100% owned QVC shopping channel, is the leading multimedia retailer with about $7.6b in annual revenue. However, a purchase of Linta at current levels ($15) could prove extremely rewarding down the road, when market conditions normalize.

Liberty recently disclosed in a press release that since the formation of the tracking stock structure, the company has repurchased approximately 14% of the Linta shares, some at prices as high as $24.95. Running some of the numbers reveals why Liberty has been aggressively repurchasing linta stock. Backing out stakes in various other assets at current market prices, and accounting for net debt, reveals an implied value for QVC of roughly $11b, or around 8.5 x TTM adjusted operating earnings (to exclude amortization charges). That seems too inexpensive for a unique, low capital intensity, prize media asset that's had a long record of consistent profitable growth, and high returns on invested capital.

In all probability, the opportunistic Liberty CEO, Greg Maffei, has his net out, and is scooping up what is being tossed overboard without regard to intrinsic value. With a substantial share repurchase authorization already in place, evidence is overwhelming that Liberty is a huge buyer of the linta tracker at these price levels and higher.

The current market quote for linta must seem illogical to the folks at Liberty, given the highly attractive economics of QVC, and the intimate understanding of the price they have paid for shares of QVC in past transactions. For example, in June of 2007, Liberty tendered for about 3% of linta shares at prices almost 70% higher than the current quote.

Furthermore, at today's price, Mr. Market's implied value for QVC is approximately 20% lower than a much "harder" and more rational appraisal made almost five years ago by Chairman Malone, just before he bought Comcast's large QVC stake for Liberty at an implied valuation of $14b. Yet QVC has delivered exceptional business progress since that 2003 purchase. In the long term, market participants will inevitably put linta on the "scale" and realize QVC is much bigger, better and stronger in every way than it was four years ago when Malone seized his opportunity to own virtually all of QVC.

This incremental value creation over the last few years at QVC is validated by the higher price Liberty recently paid for a small minority investment in QVC. In 2006, Liberty bought the approximate 2% sliver of the retailer that was in the hands of other investors, at an equity valuation estimated at $16.5b, or just under 14 x 2006 ebita (earnings before interest, taxes, and amortization of intangibles). When an analyst factors in the debt Liberty has utilized to further juice returns at QVC (and shelter income), the ebita multiple is actually higher. The key takeaway is that Liberty is a buyer of QVC, not a seller, at ebita multiples over 60% higher than those prevailing today.

QVC is just a part, albeit a major one, of the market's wrongheaded evaluation here. Liberty has a host of other assets assigned to the linta tracker that are also likely being undervalued by investors. Liberty recently bought 14m more Interactive Corp. (iaci) shares, which itself seems significantly undervalued, due to benign neglect from investors, fatigued by Barry Diller's impulsive conglomerate building. The added shares give Liberty a 30% economic interest in iaci, to go along with it's 23% stake in Expedia, (expe) where Maffei was once Chairman. With effective control, the coming splintering of iaci into five pieces also presents Malone and Co. with numerous value enhancing alternatives at Liberty.

The story is much the same at Expedia, where Diller has been searching for ways to boost shareholder value at the leading online travel agency. The company, which has counter cyclical characteristics that make it somewhat more recession resistant than most consumer discretionary businesses, is likely worth far more to interested private or strategic buyers than current market prices suggest. When credit markets reopen, Expedia will likely either attract a bid (perhaps from Liberty), or lever up and significantly shrink it's equity, increasing the value of Liberty's stake.

The evidence uncovered by piecing together the capital allocation decisions at Liberty in recent years, suggests that Malone and Maffei are still extremely bullish on "all things" linta. Their behavior with Liberty's own capital seems wholly justified, however. When you take the time to unravel some of the complex structure here and do the math entailed in a breakup analysis, it's easy to understand and identify with their optimism.

It is during challenging times like these when smart owner / operators, like John Malone, do their "magic" and create long term value for themselves, and their shareholders. Lasting wealth is built by stepping up in troubled times, and having the conviction to buy great assets, controlled by value creating managers with plenty of skin in the game. That's exactly what you get right now at both trackers, but especially so at Liberty Interactive.

4.23.2007

Dell got Punk'd

Dell is offering an "option" for users to buy Windows XP and its old technology, on a few of their systems. It turns out a "Digg" like Ideastorm blog that Dell operates, has produced a highly suspect, possibly rigged, voting system of limited economic utility. It probably has been moblogged. And this announcement of "demand" for XP by consumers is a result.

Predictably, the anti-Microsoft blogosphere has turned a routine piece of Dell PR, into yet another Microsft is "dead" storyline.

It would be stunning for a consumer to choose XP over Vista on a NEW machine which is fully capable of supporting the new technologies offered in the new OS. Stunning. I don't even think most anti-Microsoft bloggers would do that if somehow they were forced to give up their Macs and made to choose between XP and Vista. ;-)

I predict this story dies rather quickly, and we will never really find out how tiny the actual number of Dell customers choosing old over new, really is.

We only have a few more days before true facts Begin to reveal themselves in the 1st quarter Microsoft earnings release. Until then, expect the megaphone carrying critics of all things Microsoft to inundate the blogosphere with their highly biased guesswork.

4.17.2007

Hellman Friedman LLC is the New Blackstone.

What a couple of days for this buyout shop that was traveling under the radar. But then Google used some of its Google cash to buy DoubleClick, an advertising company that Hellman Friedman, a San Francisco based private equity firm, purchased a little over a year ago. According to reports in the WSJ, the firm made 10 times its money in a little over a year, cashing out a total of $3.5b on a $330m investment.

That's not all though. It also looks like these guys are going to pluck Catalina Marketing, from the not so powerful grip of ValueAct Capital, for $8.44b.

Finally, the marketing department of Hellman Friedman has been working the phones, good news in hand.  Just today, HF announced the closing of an $8.4b buyout fund. This has been quite a week for these guys.

Gosh. Hellman Friedman LLC is the new Blackstone.

3.16.2007

Alan Meckler talks his book

Alan Meckler is worth paying attention too. But it's best to watch what he does, and not what he says.

He has made a fortune as an Internet entrepreneur, and knows when to get off a fast moving train. He sold his Internet trade show businesses at the top of the bubble, and kept for himself, a large stake in a small stub of a company, then called Internet.com, which he later fashioned into Jupiter Media (JUPM).

Meckler isn't shy about touting this stock on his blog, and takes it personally when the shares are sold by investors. He usually wins in the end; but it can be a bumpy ride tagging along with Mr. Meckler.

Meckler is old-school. He's a hard core business guy who is bottom line oriented. He isn't out to squeeze every last buck from his enterprises, and doesn't mind selling assets too soon. He exited the search oriented properties of Jupiter some time ago, even as search was still a white-hot business.

Meckler isn't one to hold onto every share he owns, either. He often sells shares at opportune times. Therefore, when he comments on his stock, I listen carefully.

A recent episode provides us an example of how tough it is to make a buck by listening to CEOs on their blogs. But first, lets go back and review 2005 and 2006. Meckler was a big seller of Jupiter Media stock at prices north of $14. His timing proved fortuitous as late last year,  some problems developed at Jupiter. At that point, he stopped selling, and started talking.

Here is what he wrote last November 14th when the stock price was trading at $5.67.

"As to value, I know that our image assets, music assets and related content assets are worth a heck of a lot more than our present market capitalization. I also know that our online media division should be worth at least $2.00 a share or more. Now tack on about $35 million of EBITDA (before stock compensation). This all means (to me at least) that at our present price we are cheap. However for those out there that think we are going to zero sales, then I guess our present price is exorbitant."

When I parse this, here's what I think he is saying. There are three components to his valuation. First is the online content assets. Second, the online media assets. Third he talks about $35m of ebitda, which to me sounds like a double count, but so be it.

Meckler said that his content assets alone were worth "a heck of a lot more" than $202m, which was the market cap of the stock on Nov 14th, 2006. He then said that the online media assets were worth another $2 a share or more. The floor valuation then, according to Meckler, seems to be something pretty far north of $7.67. That was four months ago.

Fast forward to late February, 2007. Word leaks out that Jupiter is in discussions with Getty Images, a company that Meckler often rails against on his blog. The price of Jupiter quickly jumps to well over $10 a share, but backs down when Meckler makes a blog post referring to a press release issued by the company about the negotiations. Jupiter issued a press release on February 22nd indicating that indeed it was in discussions with Getty, at a price of $9.60 for ALL of jupm. I thought that was a rather low price, given what Meckler said on November 14th, only three months earlier.

Keep in mind that Getty had no use for the Jupiter online media assets, and thus had to design a deal that didn't include taking them on. It seems as though Meckler was going to be the "third party" buyer of the online media assets, which he once valued at $2 a share or more.

Meckler pulled a similar gambit when he sold his Internet trade shows to Penton Media, but retained the Internet.com "stub" that became Jupiter. That deal worked exceedingly well for Meckler, who pocketed a large sum for his trade shows, and captured more upside by retaining a large stake in a public enterprise. Now it looks like he was structuring a similar situation for himself this time around.

My hunch is that this is where negotiations broke down---the sale of the online media assets back to Meckler, and for what price. Meckler does not like to over-pay. ;-) 

Now, JUPM stock is only slightly higher than it was in November of 2006, when Meckler performed his back of the envelope valuation of Jupiter. But he is comparatively silent on the price now. The only mutterings of his were in a post on March 8th, where he wrote "Don't tread on Jupiterimages." The JUPM earnings release was delayed until mid March. When the report finally came out, the market reacted quite negatively.

The moral of this story is that while Meckler is a proven money maker, a savvy old pro that will usually win big in the end, you must be careful about following him when he speaks. ;-) In fact, it's better to watch what he does and mimic that, for example when he was selling some of his shares at high prices.

He was a substantial seller of Jupiter above $14, but appeared to want to sell the entire company for $9.60, only months after publicly valuing Jupiter at what seems to be a much higher price.

Bottom line for me: If Alan chooses to use his blog to tout the prospects of his company, Jupiter, don't fall for it. ;-) Buy Jupiter stock when HE takes out his wallet and pulls out real green money (and not via option grants) and buys Jupiter stock. And not until.

Google Is Insane

Or so said Steve Ballmer of Microsoft recently at Stanford.

The company has been trying to double its staff in a year, he added. "That's insane in my opinion," he said. "I don't think anyone has proven that a random collection of people doing their own thing has created value."

12.12.2006

Yahoo! and Facebook are Dumb

Techcrunch reports on details of the Yahoo! courting of social networking site, Facebook. Management at Yahoo! has been under the gun because it is perceived that the company is being outmaneuvered by it's rival Google. These observers suggest that Yahoo! needs to catch up and start making acquisitions. It appears it is trying.

But management at Yahoo! would flunk Warren Buffett's test on Internet company valuation because they would have flubbed an answer to a fundamental question: How do you value an Internet company? The answer to this question comes later.

Yahoo!'s answer would be unacceptable to Mr. Buffett. A key assumption here is that the Internet is a rapidly changing set of technologies, and does not lend itself to making long term DCF style projections for companies such as Facebook.

It's really impossible to know what Facebook, and the Internet, will look like in 18 months, let alone 5 or 10 years. A DCF calculation on an early stage Internet company is a foolhardy exercise. You can "project" anything you want into these models, and that's exactly what Yahoo! did.

Yahoo! though, makes a projection of Facebook's financials out to 2015, or 9 years! Its not surprising at all that these projections "justify" the absolutely astounding price of $1.6b that Yahoo! seemed willing at one stage, to offer Facebook. What does Yahoo! foresee for Facebook in 2015? Nearly $1b in annual profit! This for a company that has $50m of revenue, and probably zero profit, today.

Evidently the owners of Facebook didn't think the $1.6b offer was enough and spurned it. Thus, Yahoo! may have been saved by a financial insanity greater than it's own. And that, readers, is saying something.

By the way, the correct answer to Buffett's question of how does one value an Internet company is...a blank sheet of paper. He would give an F to anyone who even attempted a valuation.

The number crunching folks at Yahoo! would be barred from Buffett's class until they had read Benjamin Graham's The Intelligent Investor.

Link to Techcrunch

12.09.2006

Goldman is only human after all

Whoops. Underperforming common benchmarks by 27% in a year, as a big Goldman Sachs sponsored hedge fund did, isn't good. The S & P 500 is going to be up around 15% with dividends in 2006. But this fund was up 40% in 2005, when the S & P only managed about 5%, as I recall.

What happens, though, is after such strong outperformance, a lot of "new" money flowed into Alpha. That's typically what retail investors do too. They pile into hot funds, only to see them phizzle out, just after they put their hard earned money in. The big boys are no different. In this case, chasing performance at Alpha was a bad idea, given the opportunity costs.

This is a "macro" fund, with lots of leverage no doubt being applied. The managers play a highly evolved guessing game on the direction of various global markets. This year, it has been short U.S. stocks and long the greenback. Both positions have gone against this $12b fund. The recent strong rally in U.S, stocks is being fueled, in part, by funds like these reversing their wrong way bet.

The fund has never ended a year this much in the red. The folks who invest in these things have itchy trigger fingers. With the intense competition for gathering assets, Goldman Sach's Alpha could be quite a bit smaller this time next year.

go to Goldman's Alpha hedge fund off 12% for year

12.07.2006

Primedia is Fixing Itself

Primedia is an orphan stock. It trades for about a buck and half on the NYSE under the symbol PRM. It's really quite a bundle to get your arms around. First, its old media. Magazines mostly. It also is the home of Channel One, the ambitious educational TV network that never quite lived up to its hype. This business has been going south.

The big problem here though is debt. There is a ton of it, although it seems manageble. It is a private equity deal that wasn't exactly a home run for KKR, the sponsors, and now dominant shareholder.

A break up of the company is being contemplated. In fact its been talked about for over a year now, since October of 2005. It makes sense to break up Primedia because, like a lot of companies in need of restructuring, there is "good" and there is "bad" in Primedia.

Primedia announced the sale of some consumer magazines. This sale could be the sticking point in getting a spin-off of the consumer unit off the ground. A form 10-12b has been filed by Primedia. Expect an updated one soon that reflects the details of this sale.

The shares look almost fully valued in the $1.60 range, but volatility abounds here. Weakness could present an opportunity, especially if Primedia makes the announcement to break up that a very very few ;-) of us have been waiting for.

Lancaster Colony should do something

Lancaster (lanc) seems ripe for a corporate restructuring. It has three diverse businesses, one of which is highly profitable, the other two, which are smaller, lose money. If all it did was shut down the two money losing operations, the stock would go up. But I think they can better. And it looks like the folks there are considering taking action, with some kind of announcement to come soon.

This is from the latest 10q.

"In April 2006, we announced that we are exploring strategic alternatives, including potential divestitures, among our nonfood operations. This process is ongoing with the assistance of outside financial advisors, but there is no assurance that any specific transaction will result. Given the current status of the project, it is unlikely that we will see significant developments until December of this year or later."

This looks promising to me as Lancaster's best business, specialty Foods, has low teens operating margins. Carving everything off around this nice business would create a lot of value here.

Walter pours out Water

Spin-off action straight ahead. Mueller has received notices from some prominent value investors who like the stock. Its hard to predict what will happen here. Will it be dumped? Walter has a Coal business. Investors who want to own commodities may prefer Walter to Mueller. Is Mueller the prize; or is Walter going to be the prize? We will know starting in about ten days.

Walter Spin-off of Mueller

12.06.2006

Medtronic loses Physio-Control

This one looks promising. Medtronic is in a lot of indexes and this spin off will be quite small relative to Medtronic. There should be some forced selling.

The company, to be called Physio-Control Inc., will have an estimated $450 million in annual sales.

Medtronic has had a great record of results over the years. This likely is a decent business that just doesn't fit current strategy. Don't hold your breath for this one, however. The transaction is expected to be completed in the first half of Medtronic's fiscal year 2008.

Link to Medtronic to spin off external defibrillator division - MarketWatch

11.26.2006

Sun's balloon Popped

Unbeknownst to most shareholders, Scott Mcnealy and cohorts, back when he was running the show as CEO, did something important when he made two large acquisitions over the last 18 months, trading away a lot of his cash. He Pierced the Hope Balloon. Why do I say he did this? As long as Mcnealy had a lot of cash at Sun, investors could always hope that the feisty CEO would do something extraordinarily exciting, or creative, or transformational, or ideally, all of the above. But he did none of that.

Instead, well he bought StorageTek, a stuck in the mud tape and storage company that sells into the declining IBM Mainframe market, and a marginally profitable service organization called SeeBeyond.

These "bold" moves by Mcnealy have now forced the hand of Wall Street research reporters into being realistic themselves. Mostly, this terminally optimistic bunch likes to give Sun Micro the benefit of the doubt, as they wait patiently for the transformative event to happen. The possibilities of investment banking business for their firms makes the wait profitably tolerable.

Now though, with these two acquisitions, Wall Street's finest have lost this ability to let their imaginations run wild, and consider the possibilities of what might have been. Instead they will have to add the reported numbers of a very stodgy tape company (boring!) to that of a profitless computer company (equally boring). The pizzazz is gone. The HOPE is gone. The endless possibilities...gone.

The model now looks surprisingly tame and it will be unexciting for investors, until visible cracks in the Sun story again begin to show, sometime in the next 18 months or so. Then Mcnealy's wet behind-the-ears successor, Jonathon Schwartz, will have to take the Sun human resources hatchet out yet again, and lop off even more jobs, and close down even more facilities. And then the reality will be demonstrated that Mcnealy's model for Sun Microsystems was nothing more than Silicon Graphics-DELAYED.

These moves to replace cash with no-growth, albeit cash producing assets has temporarily stopped the downward spiral in the business, but in doing so, Mcnealy capped the upside of the shares. The Hope Balloon has deflated. And now all that's left is Prayer. You see, Wall Street has already marked the shares up in anticipation of rapid growth, growth that Mr. Schwartz hints at each time he speaks, or blogs, which is to say, often.

18 research analysts cover Sun and the average "guess" for its earnings in the year ending June 08 is all of $0.15. Yes folks, Sun Micro is trading at 35 x F08 guesstimates. Remember that this company hasn't made a dime from its operations since the tech bubble 1.0 burst in 2001.

These shares are way overvalued because tech investors are looking in the rear view mirror here. They see a once glorious technology company, instead of the reality, that of a profitless computer company, in an increasingly competitive business.

But there will always be bountiful Hope for Sun Management, who have been be paid exceedingly well over the past five years (since the bubble burst), for what is essentially a big cleanup job of a gargantuan mess of their own creation. Think New Orleans after Katrina. The Sun shareholders and board of directors, however, seem only too eager to let many of the same folks who created this big mess, clean it up, and at no small cost to owners.

Although SUNW shares have recently taken flight, and lofty valuations have been achieved again, the hope balloon for shareholders has popped. Its only a matter of time before the price of the stock, follows hope.

11.19.2006

Verizon wants to be Sexier

Verizon (VZ) is spinning off its directory business. They are calling it Idearc (IAR). This situation has all the signs of a classic dump of the despised "spinco". Why?

First, at least relative to Verizon, Idearc is a very small company. Large cap funds that hold Verizon will eventually have to sell the shares, so as not to violate the Morningstar style boxes, and potentially confuse fund analysts and share owners. Second, Verizon is in many indexes, including the granddaddy of them all, the S & P 500. These holders of Verizon will be forced to dump this spin-off because Idearc will not be included in any index. Third, this Yellow Pages directories business won't have the dividend yield of the parent company. That means dividend investors, including some large funds focused on providing income for shareholders, will want to sell. Fourth, directories is "old" media, and thus considered toxic waste for many investors looking for the next "Google" to turbo charge their portfolios. Idearc will be not even get a "sniff" from these gunslingers.

Finally, Idearc will have a lot of debt (~ $9b) relative to its equity---more than most institutional money managers will be comfortable with. This will make them want to sell the shares and reduce perceived risk.

All of these factors should serve to put pressure on the shares. But every business, even declining ones, hold the possibility of being a good investment, provided the price is right. Because of their stable operating characteristics, low capital requirements, and high operating margins, directory businesses are coveted by private equity investors. And of course, these investors are flush with cash at the moment, and anxious to forge deals.

Last year, a deal to buy a directory business (Dex) was done by publisher R.H. Donnelley in the 10-11 X ebitda range. Idearc, which initially will have about 146m shares outstanding, begins trading on November 20. At a an expected price of about $27 or so, total enterprise value comes in at around 7.5 X 2005 ebitda of $1.7B.

This is a slow growing business, and there will be some integration costs, at least through 2008. So eibitda will be in this general range for some time.

If Idearc gets a bit cheaper (perhaps 6-7 x ebitda), and there is every reason to think it will, Verizon's toxic excrement may become a value. In this changing world, 11 X ebitda represents a rich takeout value, given the risk that advancing Internet search technologies makes a local directory book nothing more than a waste of thin yellow paper. Therefore, 9-10 X seems a more realistic goal for investors here.

Verizon investors may well be primed to pitch this one overboard. Idearc, then, could well be a winning idea for intrepid, contrary investors.

11.14.2006

Realogy Bites Bears

It seems that a few bears think shorting this real estate services company is the pathway to riches. For a few reasons, this may not be the best of ideas. First the housing market is not uniform and that can skew the bearish statistics. Yes, there is a bubble in a few select areas of the country but there is no bubble in other areas.

Second, sellers can't sit on their hands forever. Most people that buy and sell homes Have to buy. They have to sell. They need to sell. They start families, have kids need a bigger place. They get a new job out of the area. Parents need to down size. Kids go off to college. So there is a need to sell. Sellers can sit tight for a while, but not indefinitely.

Note this is why Warren Buffett of Berkshire Hathaway loves the real estate brokerage business. Buyers Need to buy. Transactions must take place. They always have and always will. On average, over generations, people move about every six years. They move because they want to or have to. He likes the predictability of this business.

Third I wonder why, if things are so awful, Buffett is buying RE brokers hand over fist? I mean if earnings are going to disappear. I wonder why he is willing to pay premiums to buy RE brokers, and then integrate then into MidAmerica, the vessel that houses his brokerages? What does Warren know that the real estate bears don't? Wink

Now, about Realogy (h). I wonder why the single largest individual shareholder announced on a conference call that the H shares were badly mispriced at $21, and that the company would immediately buy back stock? Then, within days, he goes out and instructs the company to borrow money to buy back stock. And this is no ordinary buyback. This is a massive buyback of shares with borrowed money. This decision was made by an owner operator, Henry Silverman, who knows the business very well, talks to Realtors all the time, and knows what the long term values are for this business to private equity investors.

So real estate bears, go ahead and short the company, which is capable of returning 50% on its tangible assets, at a time when Buffett is investing heavily in brokers, all the current bubble "bad" news is in the stock, and the company itself has borrowed a large amount of money to buy in a massive amount of stock.

There must be better ways to make a living. ;-)

8.23.2006

Hanesbrands wears Women's Underwear

Sara Lee Corporation (SLE) is in the midst of a significant restructuring of the company. Part of this initiative is the spin-off of Hanesbrands (HBI), which rang up about $4.5b of revenue in 2006. Hanesbrands is a good business. But it will also be a highly leveraged one when it is hatched in early September.

So that HBI can pay a large dividend back to its parent, Sara Lee has saddled the company with $2.6b of debt. It's a crafty and totally legal way for Sara Lee to extract value from the Hanesbrands subsidiary, without resorting to an outright sale. The debt laden Hanesbrands should be trading "regular way" in the first week of September.

Hanesbrands has the kind of business economics super investor Warren Buffett adores. In fact, in recent years, Buffett has bought two highly similar businesses, Fruit of the Loom, and Russell Corp. He loves steady boring businesses and Hanesbrands fits the description to a "T". ;-)

Hanesbrands, though, may be an even better business than the two Buffett already scooped up for his company, Berkshire Hathaway. Here's why. HBI gets lots of shelf space at Wal-Mart, Target, and Kohl's, three retailers that should continue to take share from other retailers year after year.
Hanes, believe it or not, is the most recognized brand by female shoppers. The new Hanesbrands will include not only Hanes clothing, the dominant brand, but Champion sportswear, Playtex, and Wonderbra as well. These products are high volume items that are frequently replenished. Consumers make on average, 4 trips a year to places like Wal-Mart to buy exactly the kind of products that HBI sells.

Hanes sells undergarments! These items are far less subject to the whims of fashion. This is highly appealing to rational investors like Mr. Buffett. People are always going to need white T-shirts and undergarments, regardless of economic conditions. One question Buffett always asks is how much will this business change? T-shirts don't change. Underwear doesn't change (although we change underwear!). HBI has a formidable position in these stable slow growing markets. The spin-off should only help to focus and motivate management, which now has a great financial incentive to create value at this newly public company.

The market for Hanesbrands products should grow at about 4.5% per annum. For a variety of reasons, I estimate this business can grow its EBITA at 8% to 10% rates. Management has a plan to create more integration and focus at disparate units of the company, increase marketing spend, and optimize the supply chain. There is room for some moderate operating margin expansion from the 10% range. Management will have more financial incentive to improve HBI than they had when operating as a unit of SLE.

Although Hanes will be highly leveraged, management should, in the years ahead, have increasing flexibility to pay down its debt, even after funding necessary cap-ex, and paying the higher interest costs it is stuck with. Leverage works to the equity investor's advantage when there is more than enough funding to invest in operating expenses, and cap-ex, as well as pay the high interest charges. Value gets transferred from debt holders to shareholders as a highly leveraged company painstakingly pays down its debt. This seems the likely outcome at HBI. At the right price, Hanesbrands is the kind of business Buffett usually salivates over.

What is the right price for a business with the mouth watering characteristics of HBI? Luckily, all we have to do is go back a few months and examine what Buffett paid for Russell Corp. Russell has many of the same qualities as Hanesbrands. It was not as leveraged, however, and operating margins were a shade lower. Hanes has better brands, more scale, and a more diversified product line. It deserves a higher price tag. But how much higher?

Not long ago, Buffett paid about 7 x EBTIDA for Russell. By the numbers, this also works out to 10 x EBITA, or operating cash flow - maintenance cap ex. As stated earlier, Hanesbrands, as a better business capable of higher returns, deserves a higher multiple. What might a highly rational private buyer pay for Hanesbrands? My educated guess would be a price somewhere around 8 x current year's EBITDA, and 12 x current year's EBITA.

Here are some of the pertinent numbers. Hanesbrands will have 95m shares outstanding. It will have $2.6b of long term debt. Importantly, it will have an unfunded pension liability of about $360m, and $200m of cash. I add the unfunded pension liability to debt less cash, and arrive at net debt of ~ $2.8b. It looks like EBITDA came in at about $530m for 2006. 8 x ~$530m = $4.25b TEV. My proxy for operating earnings, EBITA, is about $440m for 06. 12 x ~$440m = $5.3b TEV.

The enterprise value range of HBI is $4.25b to $5.3b. But HBI is a highly leveraged company. The range for the equity values, therefore, will be much wider, as we will see. $4.25b (8 x EBITDA) - $2.8b = $1.45b/95m shares = $15.25 share price. The EBITA calculation is as follows. $5.3b - $2.8b = $2.45b/95m shares = $25.75 share price. In when issued trading, the shares are changing hands slowly for about $19. That seems just about right, for now, and provides a measure of confidence to this valuation work.

As a disciple of Warren Buffett and his investment methodologies, this business appeals to me. It would be a worthwhile portfolio addition at the right price. At first blush, however, the shares don't seem especially cheap. The stock could sell off in the weeks ahead though, as Hanesbrands may well be jettisoned from institutional portfolios for any number of reasons.

I plan to watch the trading of HBI closely and will consider buying the stock if it approaches the low end of the above calculated valuation range. Of course if it falls trough this range, all the better. Hanesbrands is one to watch, even in your skivvies. You can bet Mr. Buffett will be, although he will be wearing Fruit of the Loom. ;-)