Turnarounds

TURNAROUNDS

Traits
• No growth, potential fatalities – a poorly
managed company is a candidate for trouble
• Make up lost ground very quickly and
performance isn’t related to market moves
• Can’t compile a list of failed Turnarounds,
since their records get deleted after collapse
• Turnaround types:
i) Bail Us Out Or Else: whole deal depends
on a government bailout.
ii) Who Would’ve Thought: can lose money
in utilities?
iii) Unanticipated Problem: minor tragedy
perceived to be worse, leading to major
opportunity. Be patient. Keep up with
news. Read it with dispassion. Stay away
from tragedies where the outcome is
immeasurable.
iv) Good Company Inside a Bad one:
possible bankruptcy spinoff. Look for
institutional selling and insider buying.
Did the parent strengthen the company’s
balance sheet pre-spinoff?
v) Restructuring: company diworseified
earlier, now the loss making business is
being sold off, costs cut etc.
• How will earnings change?
i) Lower costs
ii) Higher prices
iii) Expansion into new markets
iv) Higher volume sold in old markets
v) Changes in loss making operations
• Buy companies with superior financial
condition. Young company + Heavy Debt =
Higher Risk. Determine extent of leverage
and what kind is it? Long term funded debt
is preferable to Short/Medium term callable
bank debt, which may trigger bankruptcy.
• Inventory growth > Sales growth = Red flag,
& inventory growth is a bad sign. Depleting
inventory means things maybe turning
positive. High inventory build up overstates
earnings - may mean that management is
deferring losses by not marking down the
unsold items & getting rid of them quickly.
• Asset/inventory values maybe inflated. Raw
materials are liquidated better than finished
goods. Check for pension liabilities and
capitalized interest expense in asset values.
• Upswing favours Turnarounds > Normal
companies. So look for low margin
companies to succeed via operating leverage
/ high cost of production.
• If the industry is robust in general and the
company’s business doesn’t do well, then
one maybe pessimistic about its future.
• If the entire industry is in a slump & due for
a rebound, & the company has strengthened
its balance sheet and is close to the breakeven 
point, then it has the potential to do
jumbo sales when the industry picks up.
• Name changes may happen due to M&A or
some fiasco that they hope will be forgotten.
• Are Turnarounds obvious winners? In
hindsight, yes, but a company doesn’t tell
you to buy it. There’s always something to
worry about. There are always respected
investors who say that you’re wrong. You’ve
to know the story better than they do and
have faith in what you know.
• For a stock to do better than expected, it has
to be widely underestimated. Otherwise, it’d
sell for a higher price to begin with. When
the prevailing opinion is more negative than
yours, you’ve to constantly check & re-check
the facts, to assure yourself that you’re not
being foolishly optimistic. The story keeps
changing for better or worse, and you’ve to
follow these changes and act accordingly.
• With Turnarounds, Wall Street will ignore
changes. The Old company had made such a
powerful impression that people can’t see
the New one. Even if you don’t see it right
away, you can still profit more than enough.
• Cyclicals with serious financial problems
collapse into Turnarounds. Also, fast
growers that diworseify & fall out of favour.
• If Slow Grower = Turnaround, then it’s
performance maybe > Stalwart/Fast Grower
• Remind yourself of the Even Bigger Picture –
that stocks in good companies are worth
owning. What’s the worst that can happen?
Recession turns into depression? Then
interest rates will fall, competitors will falter
etc. if things go right, how much can I earn?
What’s the reward side of the equation? Take
the industry which is surrounded by the
most doom and gloom. If the fundamentals
are positive, you’ll find some big winners.

Examples
• Auto (Ford Chrysler), paper, airlines
(Lockheed), steel, electronics, non-ferrous
metals, real estate, oil & gas, retail, Penn
Central, General Utilities, Con Edison, Toys
R Us spinoff, Union Carbide, Goodyear.
• Record with troubled utilities is better than
troubled companies in general, because of
regulations. A utility may cancel dividends /
declare bankruptcy, but if people depend on
it, a way must be found to let it continue
functioning. Regulation determines prices,
profits, passing on costs to customers. Since
the government has a vested interest in its
survival, the odds are overwhelming that it
will be allowed to overcome its problems.
• Troubled Utility Cycle:
i) Disaster Strikes: some huge cost (fuel)
can’t be passed along, or, because a huge
asset is mothballed & removed from the
base rate. Stock drops 40-80% in 1-2
years, horrifying people who view utilities
as safe & stable investments. Soon, it
starts trading at 20-30% P/B. Wall Street
is worried about fatal damage – how long
it takes to reverse this impression varies.
30% P/B implies bankruptcy, emergence
from which may take upto 4 years.
ii) Crisis Management: utility attempts to
respond by cutting costs and capex.
Dividend maybe decreased / eliminated.
Begins to look as if the company will
survive, but price doesn’t reflect the
improved prospects.
iii) Financial Stabilization: cost cuts have
succeeded, allowing it to operate on
current revenues. Capital markets maybe
unwilling to lend money for new projects
& it’s still not earning money for owners,
but survival isn’t in doubt. Prices recover
to 60-70% P/B, 2x from stage (i), (ii)
iv) Recovery At Last: once again capable of
earning and Wall Street has reason to
expect improved earnings and the
reinstatement of dividends. P/B = 1x.
How things progress from here depends
on, (a) reception from capital markets,
because without capital, a utility cannot
increase its base rates, and, (b) support
from regulators’, ie, how many costs are
allowed to be passed on?
• One person’s distress is another man’s
opportunity. You don’t need to rush into
troubled utilities to make large profits. Can
wait until the crisis has abated, doomsayers
are proven wrong, and, still make 2-4x in
short term. Buy on the omission of dividend
& wait for the good news. Or buy when the
first good news has arrived in stage (ii).
• The problem that some people have is they
think they’ve missed it if the stock falls to
$4, then rebounds to $8. A troubled
company has a long way to go and you’ve to
forget that you’ve missed the bottom.

People Examples
• Guttersnipes, drifters, down and outers,
bankrupts, unemployed – if there’s energy
and enterprise left.

2 Minute Drill
• Has the company gone about improving its
fortunes and is the plan working?
• General Mills has made great progress on
diworseification. Cut down from 11 to 2
businesses that are key and the company
does best. Others were sold at good price
and the cash was used for buybacks. 1 key
business’ market share has improved from 7
to 25% and is coming up with new products.
Earnings are up sharply.

Checklist
• Plan – how will it turnaround? Sell loss
making subsidiaries? Cut costs? What’s the
impact of these actions? Is business coming
back? New products?
• Survival – can it survive a raid by short term
creditors? Check cash/debt position, capital
structure, can it sustain more losses?
• Bottom Fishing – if it’s bankrupt already,
then what’s left for owners?

Portfolio Allocation %
• 20-50% Allocation, based on where greater
value exists - Turnarounds or Fast Growers

Risk/Reward
• High Risk – High Gain.
• Higher potential upside (10x) vs higher
potential downside (100% loss).

Sell When
• After Turnaround is complete, trouble is
over, everyone is aware of changed situation,
& the company is re-classified as a Cyclical/
Fast/Slow Grower etc. Stockholders aren’t
embarrassed to own the shares anymore.
• Stock is judged to be a 2x, but not 5-10x
• PE is inflated vs Earnings prospects, sell and
rotate into juicier Turnaround opportunities,
where Fundamentals are better than Price.
• Debt, which has declined for 5 consecutive
quarters, rises again. Indicates increased
chances of relapse.
• Inventory rise > 2x Sales increase.
• >50% sales of the company’s strongest
division’ come from some customer whose
sales are slowing down.

The Peter Lynch Playbook

Twitter@mjbaldbard 5 mayur.jain1@gmail.com

Summary of Peter Lynch’s “One up on Wall Street”

Peter Lynch ran the Fidelity Magellan between 1977 and 1990. During this time he created the most enviable US mutual fund track record by averaging returns of 29% per year. To give you an idea of the compounding effect, he would have turned $10,000 into just over $270,000 in 13 years.

General Market observations
• The advance versus decline number paint better picture then the performance
of the market than index movements.
• Do not make comparisons between current market trends and other points in
history.
• For five years after July 1st 1994, $100,000 would have turned into $341,722.
If you missed the best 30 days, would have been worth $153,792.
• "The bearish argument always sounds more intelligent"
• Superior companies succeed and mediocre companies will fail. Investors in
each will be rewarded accordingly.
• Investing in stocks is an art not a science.
• If seven out of ten stocks perform, then I am delighted, if six out of ten stocks
perform, I am thankful. Six out of ten stocks is all it takes to create an enviable
record on Wall Street.
• Stand by your stocks as long as the fundamental story of the company has not
changed.
• There was a 16 month recession between July 81 and Nov 82. This time was
the scariest in memory. Sensible professionals wondered if they should take
up hunting and fishing, because soon we'd all be living in the woods, gathering
acorns. Unemployment was 14% and inflation was 15 %. A lot people said
they were expecting this but nobody mentioned it before the fact. Then
moment of greatest pessimism, when 8 out of 10 swore we where heading
into the 1930s the stock market rebounded with a vengeance and suddenly all
was right with the world.
• No matter how we arrive at the latest financial conclusions, we always prepare
ourselves for the last thing that happened.
• The day after the market crashed on Oct 19th 1987 people started worrying
that the market was going to crash.
• The great joke is that the next time is never like the last time.
• Not long ago people were worried that oil would drop to $5 and we would have
a depression. Two years later the same people were worried that oil would
rise to $100 and we would have a depression.
• When ten people would rather talk to a dentist about plaque then to a fund
manager about stocks, then it is likely the market is about to go up.
• “The stock market doesn't exist, it is there as a reference to see of anybody is
offering to do anything foolish” - Warren Buffett
• If you rely on the market to drag your stock along, then u might as well go to
Atlantic City and bet on red or black.
• Investing without research is like playing stud poker without looking at the
cards.

Categorising stocks
When you buy into stocks you need to understand why you are buying. In doing
this, it helps to categorise the company in determining what sort of returns you
can expect. Catergorising also enforces some discipline into your investment
process and aids effective portfolio construction. Peter Lynch uses the six
categories below
• Sluggards (Slow growers) – Usually large companies in mature industries
with earnings growth below or around GDP growth. Such companies are
usually held for dividend rather than significant price appreciation.
• Stalwarts (Medium growth) - High quality companies such as Coca-Cola,
P&G and Colgate that can still churn out high single digit/low teens growth.
Earnings patterns are not cyclical meaning that these stocks will protect
you recession.
• Fast growers – Companies whose earnings are growing at 20%+ and have
plenty of runway to attack e.g. think Google, Apple in their early days. It
doesn’t have to be a company as “sexy” as those mentioned.
• Cyclicals – Companies whose fortunes are closely linked to the economic
cycle e.g. automobiles, financials, airlines.
• Turn-arounds – Companies coming out of a depressed phase as a result of
change in management, strategy or corporate restructuring. Successful
turnarounds can deliver stunning returns.
• Asset plays – Firm has hidden assets which are undervalued or not
recognized at all on the balance sheet or under appreciated by the market
e.g. cash, land, property, holdings in other company.
General observations about different types of stocks
• Wall Street does not look kindly on fast growers that run out of stamina and
turn into slow growers and when that happens the stock is beaten down
accordingly.

Three phases of growth:
• Start-up phase: during which it works out kinks in the business model.
• Rapid expansion phase: moves into new locations and markets.
• Mature phase: begins to prepare for the fact there's no easy to continue to
expand.
• Each of these phases may last several years. The first phase of the riskiest
for the investor, because the success of enterprise isn't yet established.
The second phase in safest, and also where the most money is made,
because the company is going to think about duplicating it's successful
formula. The third phase is when challenges arise, because of company
runs into its limitations. Other ways must be found to increase earnings.
• You can lose more than 50 percent of your investment quickly if you buy
cyclicals in the wrong part of the cycle.
• You just have to be patient, keep up with the news and read it with dispassion.
• After it came out of bankruptcy, Penn Central had a huge tax loss to carry
forward which meant when it had to start earning money it wouldn't have to
pay taxes. It was reborn with a 50% tax advantage.
• It's impossible to say anything about the value of personal experience in
analysing companies and trends.
• Companies don't stay in the same category forever. Things change. Things
are always changing.
• It's simply impossible to find a generic formula that sensibly applies to all the
different kinds of stocks.
• Understand what you are expecting from the stock given its categorisation. Is
it the sort of stock you let run, or do you sell for a 30-50% gain.
• Ask if any idiot can run this joint, because at some point an idiot will run it.
• If you discover an opportunity early enough, you will probably get a few dollars
off its price for its dull name.
• A company that does boring things with a boring name is even better.
• High growth and hot industries attract a very smart crowd that want to get into
the business. That inevitably creates competition which means an exciting
story could quickly change.
• Try summarise the stock story in 2 minutes.
• Ask if the company is able to clone the idea.
• For companies that are meant to be depressed you will find surprises in one
out of ten of these could be a turnaround situation. So it always pays to look
beyond the headlines of depressing companies to find out if there is any thing
potentially good about the stock.

Financial analysis
• When cash is increasing relative to debt that is an improving balance sheet.
The other way around is a deteriorating balance sheet.
• When cash exceeds debt it's very favourable.
• Peter Lynch ignores short-term debt in his calculations. He assumes the
company that other assets can cover short term debt.
• With turnarounds and troubled companies, I pay special attention to debt.
Debt determines which companies survive and which will go bankrupt in a
crisis. Young companies with heavy debts are always a risk.
• Bank debt is the worst kind is due on demand.
• Commercial paper is loaned from one company to another for short periods of
time. It's due very soon and sometimes due on call. Creditors strip the
company and there is nothing left for shareholders.
• Funded debt is the best kind from a shareholders point of view. It can never be
called no matter how bleak the situation is.
• Pay attention to the debt structure as well as amount of debt when looking at
turnarounds. Work if the company has room for maneuver.
• Inventory - The closer you get to a finished product the less predictable the
resale value.
• Overvalued assets on the left of the balance sheet are especially treacherous
when there is a lot of debt on the right. Assets can easily fall in value whilst
debt is fixed.
• Keep a careful eye on inventories and think about what the value of
inventories should be. Finished goods are more likely to be subject to
markdowns then raw materials. In the car industry new cars are not prone to
severe markdowns compared to say the clothes industry.
• Looks for situations where there is high cash flow and low earnings. This may
happen because the company is depreciating a piece of old equipment which
doesn't need to be replaced in the immediate future.

The final checklist
• P/E ratio. Is it high for this particular company other similar companies in the
same industry?
• The percentage of institutional ownership. The lower the better.
• The record of earnings to date and whether the earnings are sporadic or
consistent. The only category where earnings may not be important is in the
asset play.
• Whether the company has a strong balance sheet or a weak balance sheet
and how it's rated for financial strength

When to Sell
Slow Grower
• I try sell when there's been a 30 to 50% appreciation or when the
fundamentals have deteriorated, even if the stock has declined in price.
• The company has lost market share for two consecutive years and is hiring
another advertising agency.
• No new products are being developed, spending research and development is
curtailed, and the company appears to be resting on its laurels.
Stalwart
• These are the stocks that I frequently replace for others in the category. There
is no point expecting a quick tenbagger in stalwarts and if the stock price get
above the earnings line, or if the P/E strays to far beyond on the normal range,
you might think about selling it and waiting to buy back later at a lower price or
buying something else as I do.
Cyclicals
• Extended run in upturn means a downturn could be nearing.
• One of the sell signal is inventories are building up in the company and can't
get rid of them, which means low prices and low profits down the road.
Fast grower
• If the company falls apart and the earnings shrink, and so will the P/E multiple
that investors have bid up on the stock. This is a very expensive double
whammy for the loyal shareholders.
• The main thing to watch for is the end of the second phase of rapid growth.
Turnaround
• The best time to sell a turnaround is after its turned - around. All troubles are
over and everybody knows it. The company has become the old self that was
before it fell apart: growth companies or cyclical or whatever. you have to do
reclassified stock.
Asset Play
• When the stock price has risen to the estimated value of the assets.

Silliest things people say about stocks
• If it's gone down this much already it can't go much lower
• You can always tell when a stocks hit bottom
• If it's gone this high already, how can it possibly go higher?
• It's only three dollars a share: what can I lose?
• Eventually they always come back

Things I have seen and general advice
• Most of the money I make is in the third of fourth-year that I've held the stock.
• In most cases it is better to buy the original good company at the high-priced
than it is to jump on the next “Apple or Microsoft” at a bargain price.
• Trying to predict the direction of the market over one year, or even two years,
is impossible.
• You can make serious money by compounding a series of 20 to 30% gains in
stalwarts.
• Just because the price goes up doesn't mean you are right.
• Just because the price goes down doesn't mean you're wrong.
• Stalwarts with heavy institutional ownership and lots of Wall Street covered
that outperform the market are due for arrest or a decline.
• Buying a company with mediocre prospects just because the stock is cheap is
a losing technique.
• Selling an outstanding fast-growing because the stock seems slightly
overpriced is a losing technique.
• Don't become so attached to a winner that complacency sets in and you stop
monitoring the story.
• By careful pruning and rotation based on fundamentals, you can improve your
results. If stocks are out of line with reality and better alternatives exist, sell
and switch into something else
• There is always something to worry about.
• Stick around to see what happens – as long as the original story continues
make sense, or gets better – and you'll be amazed at the result in several
years.
• One of the biggest troubles with stock-market advice is that good or bad it
sticks in your brain. You can't get it out of there, and someday, sometime, you
may find yourself reacting to it.
• I almost didn't buy La Quinta because in important insider had been selling
shares. Not buying because an insider have started selling can be as big a
mistake as selling because an outsider had stopped buying. In La Quinta's
case I ignored the nonsense, and I'm glad I did.
• You don't have to "kiss all the girls". I've missed my share of 10 baggers and
hasn't kept me from beating the market.


http://twitdoc.com/upload/funalysis/summary-of-one-up-on-wall-street-peter-lynch.pdf

Buffett avoids companies in need of major overhauls.

It is not Buffett's intention to first purchase a company and then seek major changes.

On the contrary, he avoids companies in need of major overhauls.

Furthermore, because he will only purchase companies that possess shareholder-oriented managers, the idea of confronting management to improve shareholder returns is unthinkable.

Characteristics of Declining Companies and their Value Drivers

Characteristics of Declining Companies

            In this section, we will look at characteristics that declining companies tend to share, with an eye towards the problems that they create for analysts trying to value these firms. Note again that not every declining company possesses all of these characteristics but they do share enough of them to make these generalizations.

1.     Stagnant or declining revenues: Perhaps the most telling sign of a company in decline is the inability to increase revenues over extended periods, even when times are good. Flat revenues or revenues that grow at less than the inflation rate is an indicator of operating weakness. It is even more telling if these patterns in revenues apply not only to the company being analyzed but to the overall sector, thus eliminating the explanation that the revenue weakness is due to poor management (and can thus be fixed by bringing in a new management team).

2.     Shrinking or negative margins:  The stagnant revenues at declining firms are often accompanied by shrinking operating margins, partly because firms are losing pricing power and partly because they are dropping prices to keep revenues from falling further. This combination results in deteriorating or negative operating income at these firms, with occasional spurts in profits generated by asset sales or one time profits.

3.     Asset divestitures: If one of the features of a declining firm is that existing assets are sometimes worth more to others, who intend to put them to different and better uses, it stands to reason that asset divestitures will be more frequent at declining firms than at firms earlier in the life cycle. If the declining firm has substantial debt obligations, the need to divest will become stronger, driven by the desire to avoid default or to pay down debt.

4.     Big payouts – dividends and stock buybacks: Declining firms have few or any growth investments that generate value, existing assets that may be generating positive cashflows and asset divestitures that result in cash inflows. If the firm does not have enough debt for distress to be a concern, it stands to reason that declining firms not only pay out large dividends, sometimes exceeding their earnings, but also buy back stock.

5.     Financial leverage – the downside: If debt is a double-edged sword, declining firms often are exposed to the wrong edge. With stagnant and declining earnings from existing assets and little potential for earnings growth, it is not surprising that many declining firms face debt burdens that are overwhelming. Note that much of this debt was probably acquired when the firm was in a healthier phase of the life cycle and at terms that cannot be matched today. In addition to difficulties these firms face in meeting the obligations that they have committed to meet, they will face additional trouble in refinancing the debt, since lenders will demand more stringent terms.

Declining companies: Value Drivers

Going concern value

To value a firm as a going concern, we consider only those scenarios where the firm survives. The expected cash flow is estimated only across these scenarios and thus should be higher than the expected cash flow estimated in the modified discounted cash flow model. When estimating discount rates, we make the assumption that debt ratios will, in fact, decrease over time, if the firm is over levered, and that the firm will derive tax benefits from debt as it turns the corner on profitability. This is consistent with the assumption that the firm will remain a going concern. Most discounted cash flow valuations that we observe in practice are going concern valuations, though they may not come with the tag attached.

            A less precise albeit easier alternative is to value the company as if it were a healthy company today. This would require estimating the cashflows that the firm would have generated if it were a healthy firm, a task most easily accomplished by replacing the firm's operating margin by the average operating margin of healthy firms in the business. The cost of capital for the distressed firm can be set to the average cost of capital for the industry and the value of the firm can be computed. The danger with this approach is that it will overstate firm value by assuming that the return to financial health is both painless and imminent.

Likelihood of Distress

A key input to this approach is the estimate of the cumulative probability of distress over the valuation period. In this section, we will consider three ways in which we can estimate this probability. The first is a statistical approach, where we relate the probability of distress to a firm's observable characteristics – firm size, leverage and profitability, for instance – by contrasting firms that have gone bankrupt in prior years with firms that did not. The second is a less data intensive approach, where we use the bond rating for a firm, and the empirical default rates of firms in that rating class to estimate the probability of distress. The third is to use the prices of corporate bonds issued by the firm to back out the probability of distress.

a. Statistical Approaches: The fact that hundreds of firms go bankrupt every year provides us with a rich database that can be examined to evaluate both why bankruptcy occurs and how to predict the likelihood of future bankruptcy. One of the earliest studies that used this approach was by Altman (1968), where he used linear discriminant analysis to arrive at a measure that he called the Z score. In this first paper, that he has since updated several times, the Z score was a function of five ratios:

Z = 0.012 (Working capital/ Total Assets) + 0.014 (Retained Earnings/ Total Assets) + 0.033 (EBIT/ Total Assets) + 0.006 (Market value of equity/ Book value of total liabilities) + 0.999 (Sales/ Total Assets)

Altman argued that we could compute the Z scores for firms and use them to forecast which firms would go bankrupt, and he provided evidence to back up his claim. Since his study, both academics and practitioners have developed their own versions of these credit scores.  Notwithstanding its usefulness in predicting bankruptcy, linear discriminant analysis does not provide a probability of bankruptcy.

b. Based upon Bond Rating: Many firms, especially in the United States, have bonds that are rated for default risk by the ratings agencies. These bond ratings not only convey information about default risk (or at least the ratings agency's perception of default risk) but they come with a rich history. Since bonds have been rated for decades, we can look at the default experience of bonds in each ratings class. Assuming that the ratings agencies have not significantly altered their ratings standards, we can use these default probabilities as inputs into discounted cash flow valuation models. What are the limitations of this approach? The first is that we are delegating the responsibility of estimating default probabilities to the ratings agencies and we assume that they do it well. The second is that we are assuming that the ratings standards do not shift over time. The third is that table measures the likelihood of default on a bond, but it does not indicate whether the defaulting firm goes out of business. Many firms continue to operate as going concerns after default. 

c. Based upon Bond Price: The conventional approach to valuing bonds discounts promised cash flows back at a cost of debt that incorporates a default spread to come up with a price. Consider an alternative approach. We could discount the expected cash flows on the bond, which would be lower than the promised cash flows because of the possibility of default, at the riskfree rate to price the bond. If we assume that a constant annual probability of default, we can write the bond price as follows for a bond with fixed coupon maturing in N years.

Bond Price = 

This equation can now be used, in conjunction with the price on a traded corporate bond to back out the probability of default. We are solving for an annualized probability of default over the life of the bond, and ignoring the reality that the annualized probability of default will be higher in the earlier years and decline in the later years. While this approach has the attraction of being a simple one, we would hasten to add the following caveats in using it. First, note that we not only need to find a straight bond issued by the company – special features such as convertibility will render the approach unusable – but the bond price has to be available. If the corporate bond issue is privately placed, this will not be feasible. Second, the probabilities that are estimated may be different for different bonds issued by the same firm. Some of these differences can be traced to the assumption we have made that the annual probability of default remains constant and others can be traced to the mispricing of bonds. Third, as with the previous approach, failure to make debt payments does not always result in the cessation of operations. Finally, we are assuming that the coupon is either fully paid or not at all; if there is a partial payment of either the coupon or the face value in default, we will over estimate the probabilities of default using this approach.

Consequences of Distress

Once we have estimated the probability that the firm will be unable to make its debt payments and cease to exist, we have to consider the logical follow-up question. What happens then? As noted earlier in the chapter, it is not distress per se that is the problem but the fact that firms in distress have to sell their assets for less than the present value of the expected future cash flows from existing assets and expected future investments. Often, they may be unable to claim even the present value of the cash flows generated even by existing investments. Consequently, a key input that we need to estimate is the expected proceeds in the event of a distress sale. We have three choices:

1.     Estimate the present value of the expected cash flows in a discounted cash flow model, and assume that the distress sale will generate only a percentage (less than 100%) of this value. Thus, if the discounted cash flow valuation yields $ 5 billion as the value of the assets, we may assume that the value will only be $ 3 billion in the event of a distress sale.

2.     Estimate the present value of expected cash flows only from existing investments as the distress sale value. Essentially, we are assuming that a buyer will not pay for future investments in a distress sale. In practical terms, we would estimate the distress sale value by considering the cash flows from assets in place as a perpetuity (with no growth).

3.     The most practical way of estimating distress sale proceeds is to consider the distress sale proceeds as a percent of book value of assets, based upon the experience of other distressed firms.

Note that many of the issues that come up when estimating distress sale proceeds – the need to sell at below fair value, the urgency of the need to sell – are issues that are relevant when estimating liquidation value.

Ref:

The Little Book of Valuation

Aswath Damodaran

Turnaround and Restructuring

Zobrazit stránku: Česky

Companies often exhibit the symptoms of financial distress well before a crisis erupts. In many cases, a downward spiral is not inevitable. It can be arrested and reversed. Early detection and swift, decisive action are the keys to restoring performance and value. That is why timely and expert advice is critical.

Our turnaround and restructuring practice provides advisory and insolvency services to lenders, creditors, companies and individuals who are experiencing a wide range of difficulties, from weakening performance and reduced operating profit, to crisis marked by severe cash flow problems and the imminent threat of insolvency. 

We are able to rapidly identify problem areas, develop value-preserving and unique solutions, and then implement them swiftly and precisely. PwC is the world's largest provider of business recovery and insolvency services.

The Prague turnaround and restructuring team has many years of experience in major restructuring projects in the Czech Republic. We have provided our services to leading companies in the steel industry, the glass and porcelain industry, and the chemical industry. We focus on implementation with the aim of helping our client rather than on producing theoretical reports on different issues. This gives us depth and breadth that are unmatched in the market place.

http://www.pwc.com/cz/en/podnikove-poradenstvi/revitalizace-a-restrukturalizace

Betting on a Turnaround: John Paulson makes $1bn betting on Citigroup recovery

John Paulson, the hedge fund manager who became a billionaire after predicting the US housing crash, has seen his fund generate $1bn betting on the recovery of US bank Citigroup.

John Paulson sold almost 83m shares in Citigroup in the third quarter of last year, but still had 424m shares in the bank Photo: EPA

10:19PM GMT 24 Jan 2011

Paulson & Co, the fund he runs in New York, made the disclosure in a letter to its investors, according to Bloomberg News. Bloomberg quotes the letter from Mr Paulson as saying that its investment in Citigroup "demonstrates the upside potential of many of the restructuring investments we have added to our porfolio and our ability to generate above-average returns in large positions".

Mr Paulson sold almost 83m shares in Citi in the third quarter of last year, according to the latest filings with the Securities and Exchange Commission, but still had 424m shares in the bank.

Though Citi's fourth-quarter results fell short of Wall Street's expectations last week, the bank returned to profit last year for the first time since being rescued with $45bn of US taxpayers in 2008. Vikram Pandit, the bank's chief executive, last week had his annual salary lifted from $1 - an amount he had pledged to take until the bank was back in the black - to $1.75m.

Mr Paulson also expects the US economic recovery to accelerate this year thanks to the extension of the tax cuts agreed on by Congress and The White House late last year, Bloomberg reported.

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8280003/John-Paulson-makes-1bn-betting-on-Citigroup-recovery.html

A Brief Look at Latexx

Latexx Partners Berhad

Business Description:
Latexx Partners Berhad is a Malaysia-based company engaged in investment holding and trading of rubber gloves. The Company, through its subsidiaries, is engaged in manufacturing and sale of examination rubber gloves. Its subsidiaries are Latexx Manufacturing Sdn. Bhd., which is engaged in manufacturing of rubber gloves; Medtexx Manufacturing Sdn. Bhd., which is engaged in trading of rubber gloves and letting of glove manufacturing plant and machinery, and Total Glove Company Sdn. Bhd.

Recent Financial Results

Announcement Date		Financial Yr. End		Qtr	Period End		Revenue RM '000		Profit/Lost RM'000		EPS		Amended
10-Nov-10		31-Dec-10		3	30-Sep-10		129,878		17,625		8.19		-
06-Aug-10		31-Dec-10		2	30-Jun-10		134,483		21,551		10.39		-
03-May-10		31-Dec-10		1	31-Mar-10		126,171		20,715		10.52		-
02-Nov-09		31-Dec-09		3	30-Sep-09		80,839		14,274		7.33		-

Current Price (7/1/2011): 2.68
2009 Sales 328,473,188
Employees: 1,976
Market Cap: 586,448,320
Shares Outstanding: 218,824,000
Closely Held Shares: 59,489,900

Estimated basic EPS for 2011 = 4*8.19 = 32.76 sen
Estimated diluted EPS for 2011 = (4*8.19) x [218.824 / (218.824 + 57.55)] = 25.94 sen
At price of 2.68, the prospective basic PE = 2.68 / 0.3276 = 8.2 x
At price of 2.68, the prospective diluted PE = 2.68 / 0.2594 = 10.3 x

Year    DPS    EPS
2002    0.0      -29.7
2003    0.0     -16.9
2004    0.0     -12.0
2005    0.0        5.2
2006    0.0        4.8
2007    0.0        2.7
2008    0.0        8.4
2009    2.0       27.0
9M10   5.0       28.76   NTA  1.07

Historical
5 Yr
PE range 6.8 - 20.3
DY range 1.3% - 0.3%

10 Yr
PE range 6.6 - 19.3
DY range 0.6% - 0.2%

Capital Changes

2006 Capital Reconstruction

Warrant   57.55m units   Maturity 6/6/2017   Ex Pr RM 0.53

A Brief Look at Berjaya Corporation Berhad: A very complicated conglomerate

Berjaya Corporation Berhad Company

Business Description:
Berjaya Corporation Berhad is an investment holding company and is engaged in the provision of management services. The principal activities of the Company and its subsidiaries include financial services; marketing of consumer products and services; restaurants; property development and investment in properties; development and operation of vacation time share, hotels and resorts, water theme park and operating of a casino; operations of toto betting; leasing of online lottery equipment; manufacture and distribution of computerized lottery and voting systems; publication, printing and distribution of daily newspaper; manufacturing, and investment holding and others. During the fiscal year ended April 30, 2009 (fiscal 2009), the Company acquired 100% interest in Berjaya North Asia Holdings Pte Ltd (BNAH). In September 2009, the Company announced that acquisition of a wholly owned subsidiary, ecosway Japan K.K.

1Q11 Turnover:
Toto betting operations 47.8%
Financial services 8%
Property investment & development 2.8%
Hotel & resort 4.2%
Marketing 32.8%
Others 4.4%

2002 EPS -106 DPS 0.0
2003 EPS -80.6 DPS 0.0
2004 EPS 15.9 DPS 0.0
2005 EPS -30.9 DPS 0.0
2006 EPS -2.8 DPS 0.0
2007 EPS 4.0 DPS 2.9
2008 EPS 2.8 DPS 4.3
2009 EPS 3.7 DPS 3.3
2010 EPS 2.1 DPS 1.0
1H11 EPS 4.85 DPS 5.0(Proposed)

Current Price (7/1/2011): 1.23
Market Cap: 5,179,003,560
Shares Outstanding: 4,210,572,000
Closely Held Shares: 1,953,945,595

Estimated EPS for FYE 2011 = 2*4.85 = 9.7 sen
Projected PE for FY 2011 = 12.7 x

Historical
5 Yr
PE range 13.3 - 41.6
DY range 6.6% - 1.8%

10 Yr
PE range 11.3 - 34.3
DY range 3.3% - 0.9%

Recent Financial Results

Announcement Date		Financial Yr. End		Qtr	Period End		Revenue RM '000		Profit/Lost RM'000		EPS		Amended
30-Dec-10		30-Apr-11		2	31-Oct-10		1,719,909		137,427		1.97		-
29-Sep-10		30-Apr-11		1	31-Jul-10		1,744,567		187,390		2.88		-
30-Jun-10		30-Apr-10		4	30-Apr-10		1,887,330		253,738		3.41		-
31-Mar-10		30-Apr-10		3	31-Jan-10		1,660,417		-97,041		-3.72		-

Capital Changes

2010 25/1000 Distribution of BjMedia shares

ICULS Amount 233.53m Maturity 30/10/2015 Rate 0% Conv. Pr. RM 1.00

Are Cyclical stocks also Value stocks? Value stocks usually earn money, turnaround stocks may not.

What are the characteristics of value stocks?

1. True value investors only buy if a stock is trading substantially below its tangible book value.  It’s hard finding these types of situations in all your investments.  Use this as a guide and not as a “must have.” Over the years, you will have noticed these types of values in the banking, energy and chemical industries, among others.
2. Another factor you need to find in a value stock is a low price to earnings (“P/E”) ratio.  You are looking for a beaten down stock in an out-of-favor industry. A nice P/E discount is 20% to 50% of the industry average over a few years. You then have the potential to make a nice return on both the natural rotation of the industry to a higher timeliness, as well as the stock regaining market favor. 

When is a cyclical stock also a value stock?


Many investors view cyclical stocks as value stocks. Cyclical stocks are value stocks only if they sell at an earnings (P/E) discount to their peers and meet the book value criteria as mentioned above. 




When is a cyclical stock not value stocks but a turnaround stock?


If the company is selling at a discount to its tangible bookvalue, but its earnings have disappeared, it becomes a possible turnaround situation and not a value stock.

A quick look at Latexx

A quick look at Latexx
http://spreadsheets.google.com/pub?key=tCBaT5VvGDp2xCY3zXOPcLQ&output=html

Read an analyst who mentioned that this company may target an earning of RM 100 million in a year's time.  How probable is this?   Your speculative guess is as good as mine. ;-)