Source: http://online.barrons.com/article/SB50001424052970204331604576104252848553210.html#articleTabs_panel_article%3D1
By LAUREN R. RUBLIN | MORE ARTICLES BY AUTHOR
Meryl Witmer, Marc Faber, Mario Gabelli and Oscar Schafer share their investment picks for 2011 in the final
If you're looking for compelling investment ideas and insights into how to unearth them, you've come to the right publication. That is especially so in any week when stock pickers extraordinaire Meryl Witmer, Mario Gabelli and Oscar Schafer grace these pages together. Add Marc Faber, whose 30,000-foot view of the markets encompasses both hemispheres and all asset classes, and you've got yourself the handiest guide we know to making money in 2011.
On Jan. 10, the editors of Barron's were fortunate to get all four -- and the other six members of the Roundtable -- in the same room at the same time, to explore the prospects for the global economy, financial markets and a wide array of investments in the year ahead. This week's Roundtable issue, the last of three, features the picks of this formidable foursome, and their stock-picking strategies.
Meryl, a general partner at New York's Eagle Capital Partners, says it's a lot harder to find cheap stocks now that the market has rallied. That is why she and her team are prowling for companies recently released from bankruptcy protection -- a process that cleanses their balance sheets but wrecks their reputations. The more unloved they are, the more Meryl loves them -- and the opportunities they offer.
Mario, the big boss at Gamco Investors in Rye, N.Y., has a keen interest in break-ups, make-ups, spinoffs and split-ups -- the Page Six of corporate life. That's because deals are "one way for values to surface." Deal stocks likeFortune Brands and Sara Lee figure prominently among his picks for 2011, along with a novel play on shale gas and another on gold.
Brad Trent for Barron's
From left, Marc Faber, Oscar Schafer, Meryl Witmer and Mario Gabelli share the stock-picking spotlight in this week's issue.
For Oscar, the value hound who runs New York's O.S.S. Capital, it's the catalyst that counts. What circumstance, or constellation of events, could turn an otherwise ordinary business into a growth machine? He homes in this year on companies returning to public hands after leveraged buyouts. Shares outstanding are limited, tax rates are low and management is cost-conscious -- an optimal set-up for outsized investment returns. Hertz is one such returnee, and his masterful analysis is worth reading twice.
As for Marc, a globe-trotting financial advisor, he's prone to big pronouncements. Nothing to get alarmed about -- just that all paper currencies are doomed and World War III has begun. When the shock wears off, however, you might be riveted by his thoughts on how to profit from great global shifts, as well as temporary dislocations in equity, currency and commodity prices. Think energy, gold and, yes, Japan.
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Barron's: Meryl, what good ideas have you brought us?
Witmer: I have five stocks. The first is Rockwood Holdings [ticker: ROC]. It has about 76 million shares outstanding and trades at 39.50, for an equity capitalization of about $3 billion. It was taken private by KKR and came public again in 2005. Throughout the LBO [leveraged buyout] and since, it has been managed by Seifi Ghasemi, a superb CEO. Rockwood makes advanced materials and high-value-added specialty chemicals, including lithium, titanium dioxide and ceramics. We love the lithium business. Rockwood processes lithium from a brine pumped from underground and concentrated in large ponds in the desert in Chile and Nevada. It also produces potash from these brines. Rockwood's lithium compounds are used in batteries, pharmaceuticals, alloys and ceramics.
Jennifer Altman for Barron's
Meryl Witmer
The lithium market has grown by 10% compounded in the past decade, and there is real home-run potential if electric cars gain popularity. A million all-electric cars would double demand for battery-grade lithium. Rockwood also makes titanium dioxide, an essential product used to improve the durability and opacity of plastics, paints and cosmetics.
Schafer: And paper.
Witmer: Yes. Rockwood has a grade that is used to make synthetic fibers, which should benefit from high cotton prices. There is no affordable substitute for titanium dioxide. If you don't have it in car and house paints, the rain would wash the paint off over time. Seven percent of industry capacity was shut down and dismantled during the downturn. Now demand is rebounding, and there is pricing power for the first time in a decade.
Is capacity starting to expand?
Witmer: No expansions have been announced because titanium dioxide is made from a heavy mineral called rutile and there is limited capacity to produce it. You would never consider a plant until you locked in rutile supply. Also, prices aren't yet at the point where companies would want to add capacity. There is a long runway of strong pricing ahead since it takes four-plus years to add capacity.
Schafer: If plants were closed, isn't the rutile still around?
Witmer: Rutile-ore bodies run out after five to 10 years. Rockwood buys rutile on the open market and will pass through cost increases. Rockwood's advanced-materials business produces high-performance ceramics used in the electronics, automotive and medical markets, including the hip-joint market, where its all-ceramic joint has a high market share. Pro forma, including the sale of its plastics business, which closed [Jan. 7], Rockwood could earn about $2.40 a share in 2011. Adding back excess depreciation and amortization from the step-up of asset values stemming from the LBO, and using a cash tax rate of 20%, free cash flow will be about $4.10 a share in 2011 and $4.50 in 2012. We target a price-to-free-cash-flow multiple of 12. Our one-year price target is 55.
Tronox [TROXV] also manufactures titanium dioxide. It is expected to emerge from bankruptcy protection soon and is trading on a when-issued basis at 94. Tronox succumbed to the bankruptcy process because of legacy environmental liabilities with which it was saddled during its spinoff fromKerr-McGee [KMG] in 2006. These liabilities were from other businesses and should have stayed with Kerr-McGee, which also saddled Tronox with too much debt. Bankruptcy really is a cleansing process. The bankruptcy plan set up a trust for the environmental liabilities.
How big were the liabilities?
Witmer: They put about $270 million into the trust. A lot of Tronox debt has been converted into common stock. Once the bankruptcy plan is affirmed, there will be 15 million shares trading, for an equity capitalization of $1.4 billion. The company will have about $400 million of net debt.
Tronox's plants are valuable because they produce titanium dioxide using a proprietary chloride method, which is lower-cost and produces a grade required by certain end users. Only five companies have this technology. Tronox's joint venture in Australia also mines the key raw materials needed for production. It protects the supply source, and partially insulates the company from increasing costs.
What could Tronox earn post-bankruptcy?
Witmer: Earnings power in the next year is between $8.50 and $10 a share, rising to $11 or $12 as titanium-dioxide pricing reaches a level commensurate with the capital investment required. This squares with our estimate of replacement value of $100 to $125 a share. Our target for Tronox is 120 to 140 a share.
Black: How many years of rutile reserves do they have?
Witmer: They are in a good spot for as much as seven years.
Meryl Witmer's Picks
| Price | |
| Company/Ticker | 1/7/2011 |
| Rockwood Holdings / ROC | $ 39.67 |
| Tronox / TROXV | 94.5 |
| Six Flags Entertainment / SIX | 56.58 |
| Collective Brands / PSS | 20.94 |
| Spansion / CODE | 20.88 |
Source: Bloomberg
Six Flags Entertainment [SIX] emerged from bankruptcy protection last year. It has 27 million shares and an equity cap of $1.5 billion. It has about $900 million of debt. The company said replacement value for its assets is $5 billion to $6 billion. Six Flags owns about 20 family-oriented amusement and water parks in the U.S. and Canada. We got interested when we read that Jim Reid-Anderson had been brought in as CEO. He ushered another investment of ours, Dade Behring, through the bankruptcy process, ultimately selling it to Siemens[SI]. Dade went from 10 to 77 a share.
Jim stayed at Siemens, integrating two other acquisitions. He and his team met their cost-cutting target in the first year. Six Flags gave him a compensation package that rewards success with company shares. Jim is oriented toward paying down debt, improving return on assets and running the business properly. He brought some of his team from Dade Siemens, and moved Six Flags' headquarters from New York to Dallas, saving $16 million a year. If he can get Ebitda [earnings before interest, taxes, depreciation and amortization] to $350 million, he will receive 1.25% of the stock. Six Flags gets about 25 million visitors a year, each spending about $36, all in. If he can increase profitability by $3 per person with a combination of cost cutting and higher revenue, he should meet his target. Longer-run, Six Flags has opportunities in international licensing. It also has 1,000 undeveloped acres.
Why did the company seek bankruptcy protection?
Gabelli: Dan Snyder, owner of the Washington Redskins, gained control of the company in 2005 through a proxy fight. He and his team loaded it with debt.
Black: Has Snyder left the company?
Witmer: Yes. Six Flags will have after-tax free cash flow of about $5.50 a share in 2011, which is worth 12 times earnings. That implies a stock price of 66. My cash-flow estimate assumes Six is a full taxpayer, while in fact the company has about $1.2 billion of net-operating-loss carryforwards, meaning it will pay almost no tax for the next 10 years. The present value of the NOLs is about $9 a share, which gives us a target price of 75 a share. If Jim falls short, it still is a good investment. The stock is 55.
Black: This isn't an industrial company. It is a marketing company. It is one thing to sell ball bearings. It is another to compete against Walt Disney[DIS]. Did they bring in some professional marketers?
Witmer: They brought in Al Weber, who ran Paramount Parks, and a new marketing team.
Collective Brands [PSS] trades for 21 a share. The current CEO, Matt Rubel, hails from Cole Haan, where he did a great job. At Collective he purchased Stride Rite, and got a stable of brands with a lot of growth potential. The domestic Payless stores are a cash cow. Store count isn't growing in the U.S., but it is growing internationally, especially in South and Central America. Collective's performance and lifestyle group includes Sperry Topsider, Saucony, Stride Rite and Keds. Sperry has a lot of potential in apparel, and potentially the cache of brands like Burberry [BRBY.U.K.]. Rubel's goal is to grow operating profit by 9% to 12%, and earnings per share by 12% to 16% over the long term, using debt reductions and buybacks to boost the growth rate.
What do you see for the stock?
Witmer: Collective earned about $1.50 a share in the past 12 months. Add back excess depreciation of about a dollar a share. The company has a base after-tax, free-cash-flow run rate of about $2.50 a share. The current stock price is too cheap. In the near term, increased prices for raw materials will be a headwind. But lease costs in the U.S. are decreasing. The stock could trade for 28 a share, and if things pick up with the branded part of the business, it could double.
My last pick is a flash-memory producer, Spansion [CODE]. It, too, came out of bankruptcy. Spansion entered the global downturn with too much debt. It sought bankruptcy protection in the first quarter of 2009 and exited in May 2010 with a cleaned-up balance sheet and an excellent new CEO, John Kispert. There are 60 million shares out, the stock price is 21, and the market cap is just under $1.3 billion. It has about $450 million of debt and $330 million in cash.
There are two types of flash memory -- NAND and NOR. Spansion makes NOR. NAND is great for storing data like photos or movies. NOR is used to store computer code, because it can be accessed quickly and executed reliably. Code stored on NOR reminds an electronic device what it does. You find it in cable boxes and autos. Spansion and Numonyx, which was purchased byMicron Technology [MU], have a combined 60% market share.
Fred, do you know this company?
Hickey: Not really. It is a commodity product, and those products got killed in the recession.
Witmer: It was a moment in time and a lot of things traded down. Now they are making a lot of money. Spansion lost market share when it entered bankruptcy, but now is regaining it. The market that slowed the most was the part related to cellphones, and they got out of that segment.
Spansion has $1.7 billion of NOL carryforwards. It will pay a very low tax rate for the foreseeable future. It also is suing several companies for unauthorized use of its intellectual property. We aren't counting on a big payday, but a victory could be worth a couple of hundred million. Annualizing Spansion's fourth-quarter guidance, the company will have after-tax free cash flow of $2.70 to $3.70 a share. At 21 a share, it is compelling.
Thanks, Meryl. Marc, you're on.
Faber: One investment theme I like for 2011 is LNG, liquefied natural gas, because oil demand, which declined in the developed world in the past two years, has begun to turn up. Also, emerging economies continue to grow. For the first time in history, oil demand is larger in emerging economies than in the developed world. That could create a favorable environment for energy and energy-related equities. Eventually, we will have war, big-time. Then energy prices and other commodity prices will go up substantially.
Gabelli: Can you define "big-time"?
Faber: We have a superpower in the world, the U.S., and a rising economic power, China. They have very few common interests except commercial interests, in that China wants to sell to America. But China doesn't depend as much on America as it used to, because China's exports to the developing world now exceed what it sends to the developed world. Also, countries such as Australia and Brazil have become China-centric, as their exports to China are larger than to the U.S. This creates an unstable international environment that could lead to tensions. Maybe you don't have divisions of tanks facing each other, but it should be clear that China is an active supporter of North Korea and the Taliban. And now, with the U.S. endorsing a seat for India on the U.N. Security Council, the Chinese are getting closer to Pakistan. I want to be hedged for complete disaster -- World War III. In that case, you are better off in commodity-related investments.
Sure, uranium.
Faber: If you have a bearish view of the world, you should be in equities and commodities, not government bonds. I would own a basket of oil-related equities such as Chevron [CVX], ExxonMobil [XOM] and Occidental Petroleum [OXY]. The cheapest energy is natural gas. It is volatile and depressed. A few years ago I recommended cotton, which was around 50 cents a pound. Everyone said, "There's a big glut of cotton." That is precisely when you buy commodities -- when there is a glut and prices are depressed. Then you wait. If you buy a natural-gas ETF [exchange-traded fund] and gas prices don't move, you'll lose money. But you can buy natural-gas stocks such asChesapeake Energy [CHK]. I am not saying it is a perfect company, but if natural gas goes up, the stock can move significantly.
Natural gas is abundant. Why would it rally?
Gabelli: What drives natural-gas prices is cycles. At $4.40 per million Btu, it is cheap relative to other energy inputs.
Faber: It is cheap and clean. Some coal companies also are interesting.SouthGobi Resources [SGQ.Canada] is speculative. It has a lot of coal 40 kilometers from the border of China, in Mongolia. The company is a spinoff ofIvanhoe Mines [IVN]. I am on Ivanhoe's board. Ivanhoe still has a large holding in SouthGobi, but it is independently run, if that is possible in the Friedland stable. [Robert Friedland is Ivanhoe's CEO.]
Schafer: How will SouthGobi get coal to the people who use it?
Faber: It is shipping the coal by truck, but it is likely they will build a railroad. It is a politically charged situation, because the Mongolians are afraid that once a railroad goes through, it would facilitate an invasion by China.
Jennifer Altman for Barron's
Marc Faber
For the past few years I have been positive on emerging economies. But I agree with the view here that some stocks in the West have become attractive. Archie recommended insurance companies in America. The Swiss stock market suffers from the same syndrome as Japan -- a strong currency. Swiss stocks, priced in Swiss francs, haven't really moved since 1998. Nor has the Swiss insurance industry done well. A basket of Swiss insurers including Zurich Financial [ZURN.Switzerland], Swiss Life[SLHN.Switzerland] and Swiss Re [RUKN.Switzerland] are attractive at current valuations.
Zulauf: You're not afraid they will be hurt by their holdings of European government bonds?
Faber: Swiss insurers don't own a lot of Greek, Portuguese and Spanish bonds. Zurich Financial yields 6%, astronomical compared to Swiss interest rates. The market is saying it doesn't trust the dividend. But even if it is cut by 50%, you'll have a 3% yield, still is better than Swiss bonds.
Cutting the dividend wouldn't do the stock any good.
Faber: The stock probably has discounted a potential cut already. I hear it might not happen.
I have repeatedly recommended physical gold and gold shares. Fred and others have discussed the reasons to hold physical gold outside the U.S., and I would do the same. The custody of assets will become increasingly important for investors. You shouldn't have your $1 billion in the American banking system, where the government might take it away one day or prevent it from moving overseas. You don't want to own gold in America, where expropriation is a possibility, as happened in 1933. You want to hold it in custody in Singapore, Australia, Dubai or Hong Kong.
Marc Faber's Pick
| Price | |
| Company/Ticker | 1/7/2011 |
| ENERGY | |
| Chevron / CVX | $91.19 |
| ExxonMobil / XOM | 75.59 |
| Occidental Petroleum / OXY | 96.19 |
| Chesapeake Energy / CHK | 26.95 |
| SouthGobi Resources / SGQ.Canada | C$13.50 |
| SWISS INSURANCE STOCKS | |
| Zurich Financial / ZURN.Switzerland | 248.80 CHF |
| Swiss Life / SLHN.Switzerland | 142.7 |
| Swiss Re / RUKN.Switzerland | 52.6 |
| GOLD | |
| Newmont Mining / NEM | $56.89 |
| Buy: Barrick Gold / ABX | 49.1 |
| Sell: Barrick Gold options* | 4.15 |
| ASIAN STOCKS | |
| Chiang Mai Ram Medical / CMR.Thailand | 46.00 baht |
| AEON Thana Sinsap / AEONTS.Thailand | 32.5 |
| MCOT / MCOT.Thailand | 29 |
| Ascott Residence Trust / ART.Singapore | S$1.24 |
| JAPANESE STOCKS | |
| Nomura / NMR | $6.52 |
| NTT DoCoMo / DCM | 17.11 |
| Mizuho Financial / MFG | 3.88 |
| Mitsubishi UFJ Financial / MTU | 5.31 |
| OTHER | |
| Market Vectors Gulf States Index / MES | 24.13 |
| Oslo Bors / OSLO.Norway | 77.00 NOK |
| *July 2011 50 calls. | Source: Bloomberg |
Schafer: How would you view Switzerland with regard to expropriation?
Faber: If the U.S. expropriates gold, the government won't take it away without paying for it. It will pay you the going price per ounce. Then overnight it can revalue gold to $10,000 an ounce. The U.S. would put enormous pressure on the Swiss national bank and on others to do the same. The Chinese will tell them to get lost. Thus, you should have a safe-deposit box in Hong Kong for your gold.
Among gold producers, I would ownNewmont Mining [NEM] andBarrick Gold [ABX]. If you are concerned about a near-term correction in gold, you can buy Barrick shares and sell the July 50 calls.
Water and fertilizer, or potash, are interesting opportunities. I have been recommending fertilizer stocks like PotashCorp [POT], which will be taken over at some point. It got a bid from BHP Billiton [BHP] but the bid is off. I am a little cautious about agricultural commodities, but fertilizer stocks are still attractive. And, as always, I have some Asian recommendations.
We were waiting for those.
Faber: Markets in Asia no longer are inexpensive. But based on dividend yields, which compare well to bond and cash yields, shares aren't expensive, either. You can assemble an attractive basket of Asian shares that yield 5% and have a P/E [price/earnings ratio] of around 10 times earnings. I recently bought Chiang Mai Ram Medical [CMR.Thailand], a hospital-management company. Health-care expenditures per capita are around $7,000 in the U.S. In India they are less than $50, and in China they are around $80. It is a no-brainer that health-care expenditures will grow in the developing world, along with spending on pharmaceuticals.
Witmer: Does Chiang Mai Ram make money?
Faber: It makes a lot of money. Do you think hospitals in Thailand operate for free? The P/E is about 12. Then there is AEON Thana Sinsap[AEONTS.Thailand], a consumer-finance company with a P/E of 10 and a yield of 6%. MCOT [MCOT.Thailand] is a communications company, partly state-owned. It has a yield of around 5% and a P/E of 10. In Singapore there isAscott Residence Trust [ART.Singapore]. If you are moving to Asia or within Asia, you can't find an apartment overnight, so you stuff your family into a residential hotel until you do. Ascott yields 5.6%.
If energy prices keep rising, Middle East stock markets will go up. You can participate in the markets through the Market Vectors Gulf States Index[MES] ETF. Russia and Kazakhstan would also benefit from rising oil prices. The quality of their bonds would improve. A year ago I recommended Norway's stock exchange, the Oslo Bors [OSLO.Norway]. I still like it. It yields 10%. It is a cheap stock and might be taken over. We haven't talked about Japan, the second-largest economy in the world.
Let's do it.
Faber: The Japanese market has been a huge underperformer. Government debt equals about 200% of GDP [gross domestic product]. The government will have to monetize it sooner or later. Eventually they will drive people out of fixed-income securities and cash and into currencies other than the yen. A weakening yen would be key to the improved performance of Japanese stocks. In 2011 the Japanese stock market could surprise investors on the upside. I would buy a basket of stocks, including Nomura Holdings [NMR], NTT DoCoMo [DCM], Mizuho Financial [MFG] and Mitsubishi UFJ Financial [MTU]. You can prosper by buying what no one else wants.
All paper currencies are doomed. But I am not as bearish as some on the U.S. dollar. It could surprise on the upside for a couple of months, and the yen, euro, Swiss franc and some commodity-related currencies could weaken.
There is an absence of short recommendations here today, which is unusual. I agree with Fred that in a money-printing environment you don't want to short. But going back to cotton, it recently hit $1.59 a pound. There isn't a permanent shortage; when the price gets too high, they'll plant more. But I would consider shorting cotton. I would also short the Standard & Poor's 500 as a trading position. Sentiment is overly optimistic, insider selling is heavy and the market's internals have been worsening. A lot of well-to-do people are up to here in cash. They completely missed the rally from the lows in 2009. They might be forced into the market and push it up. You could get a spike in stocks, and a shorting opportunity.
Thank you, Marc. Mario, you're on.
Gabelli: Genuine Parts [GPC] has 158 million shares. The stock is around 50. The company has net cash of $50 million. Earnings will accelerate, in part because they are gaining back share in the do-it-for-me auto-repair market. The automotive-parts group will account for 50% of 2010's $11 billion of revenue. The other business is the sale of maintenance and repair parts for industrial customers. That business was depressed and will recover.
Genuine Parts could earn $2.90 to $3 a share for 2010. This year they could do $3.45, going to $3.90. In the next five years, the company could see 10% annual earnings growth. The dividend is $1.64 a share, and the yield is 3.5%, which will grow nicely. There are 250 million cars on the road in the U.S., and their average age is increasing. The same is true for the truck population. Auto production was up sharply in 2010 as car inventory was rebuilt. Sales will rise in 2011 by about a million units, but production will rise by only 700,000. Class A trucks will be strong for the next three or four years. Globally, China is the big dog as global production increases.
What else do you like?
Gabelli: We had 10-baggers in a bunch of companies. Tenneco [TEN] went from 30 to 1 and is now 45 a share. My next idea ties into drilling technology. The world is long shale [natural gas trapped in shale]. The gas couldn't be unlocked until companies developed ways to drill horizontally with fracturing of the shale. National Fuel Gas [NFG] is a conservative way to participate. The company has 82.1 million shares and sells for about 68. Its local gas utility in Buffalo is worth about 19 a share. It has a pipeline business in the Marcellus shale, which runs from West Virginia through parts of New York, and some production in the Gulf of Mexico and California. All that, with the utility, is worth $40 a share.
Mario Gabelli's Picks
| Price | |
| Company/Ticker | 1/7/2011 |
| Genuine Parts / GPC | $50.98 |
| National Fuel Gas / NFG | 68.39 |
| Fortune Brands / FO | 61.47 |
| Sara Lee / SLE | 17.43 |
| Madison Square Garden / MSG | 24.93 |
| Energizer Holdings / ENR | 72.3 |
| Thomas & Betts / TNB | 47.6 |
| Crane / CR | 41.65 |
| Millicon International Cellular / MICC | 95.98 |
| U.S. Cellular / USM | 49.52 |
| Brink's / BCO | 26.76 |
Source: Bloomberg
NFG owns most of the land it has drilling rights to. When you drill, the first few thousand feet of shale is the Upper Devonian. You will find gas in 98% of your wells. Below that is the Marcellus, and further down is the Utica. The Utica fields are likely to be more prolific. Some companies just lease the Marcellus, but when you own the mineral rights, you can drill all the way down. Atlas Energy[ATLS] has done a deal in this area with Chevron, in which it priced land at $7,000 to $8,000 an acre. Here you're paying 28 a share times roughly 80 million shares, or $2.4 billion, for something that could be worth as much as $8 billion. NFG is in the final stages of figuring out who its partner will be. These are utility guys who backed into a technology play. They didn't understand it but they learned very quickly.
Jennifer Altman for Barron's
Mario Gabelli
I left my props home today. I was looking for a bottle of Jim Beam.
Why?
Gabelli: Fortune Brands [FO] is splitting in three. What are the parts worth? The stock is 61. The company has been whittled down in the past five years to three businesses. One is spirits. Spirits, beer and wine is an $830 billion business worldwide. Bourbon is one of Fortune Brands' fastest-growing products. The company will spin off its distilled-spirits business. The second business is housing products, including brands such as Moen, Master Lock and Aristokraft. The third business is golf products.
Fortune Brands has a $9.6 billion equity value and $3.6 billion of debt, for a $13 billion enterprise value. Earnings will grow nicely in the next few years. Bill Ackman of Pershing Square pushed for a break-up of the company, but he moved it in the direction it was going anyway. Fortune Brands should earn about $2.80 a share in 2010, and absent a break-up, earnings would march straight to $6 in 2014. Debt would come down at an accelerating rate. If there were no break-up, the company could be worth more than 110 a share. Spirits is attractive, and the housing business will recover.
Not any time soon.
Gabelli: I agree there is a big inventory overhang in housing. We don't look for much of a recovery until 2012. In the golf business, they paid about $800 million for Cobra and sold it for $100 million, so they had a big capital loss. They have a high tax basis on the golf business. It is an important dynamic of the split-up. There could be a bidding war for the spirits business. I assume it is worth 12 times Ebitda, and you could get a premium for it.
Next, coffee is a $58 billion-a-year industry. People in developing markets are drinking more coffee, and the single-serve market is growing by 30% a year. It probably accounts for $3 billion. The coffee market will grow by 6% a year in the next five years, and the tea market by 9%, from $34 billion to nearly $52 billion. How to play this? Sara Lee [SLE]. It has 639 million shares and trades for 17.50. It has about $500 million of cash from the sale of assets. It is looking to split itself up. [Sara Lee announced a split-up Friday morning.] A Brazilian company is reported to be circling the meat business. We have $23 of value today. We are looking at who will buy the coffee business.
Private-equity firms are interested.
Gabelli: They are circling. The company is in play. The best play in single-serve coffee is Nestlé [NSRGY]. But I am look for split-ups and takeovers, a subset of financial engineering. Deals are one way for values to surface.
Since we last met, there is a new company, Madison Square Garden[MSG]. It has 62.3 million A shares, of which the Dolan family owns 2.5 million. There are 13.6 million B shares; the Dolans own them all. The stock is selling for 24. The economic value of the company isn't in the New York Knicks or Rangers but in Madison Square Garden's cable networks. They have 16 million subscribers. They receive $2 per month per subscriber. The value of the cable networks equals the market value of the company, so you are getting everything else for free.
What are they using the cash for?
Gabelli: They are spending $800 million to redo the Garden over several years. If the company were going private, it would have to pay probably 55 a share. That number will rise substantially. They have air rights over the Garden, which are valuable. They have naming rights for lots of venues.
Energizer Holdings [ENR] hasn't done much in the past two years. It sells batteries, shaving products and other consumer products. There are 70.6 million shares and the stock is 70, so that's a $4.9 billion market cap. They have about $2 billion of debt. Earnings for the fiscal year ending Sept. 30 will be about $6.15 a share on $4.5 billion of revenue. They will have a hiccup in the first quarter, but earnings could climb to $10 a share by fiscal 2015.
Schafer: Driven by what?
Gabelli: They will be virtually debt-free by 2015. Ebitda is close to $900 million, and that will keep rising. The battery business is low-growth but a great cash generator. It is a $47 billion business over all. The wet-shave market is $14.5 billion at retail globally. Energizer sells the Schick brand and just bought American Safety Razor out of bankruptcy. The company makes acquisitions and diversifies neatly. It also sells off brands, monetizing their value.
With the industrial world recovering, there is a greater need for electricity. Our play, Thomas & Betts [TNB], is in the energy-efficiency business and has 51.6 million shares. It sells for about 48 and debt is $315 million. We were large holders of Baldor, which was acquired by ABB [ABB] for 13 times Ebitda. This company sells for 6.5 times 2011 Ebitda. It will earn about $2.70 a share in the year just ended, and earnings will march up to $6 by 2014. It is an important component supplier in the low-voltage electrical-products market. This is a $45 billion market. In power systems, they have an addressable market of close to $115 billion, growing 5% to 6% a year. Thomas & Betts generates a lot of cash. The company will have $18 a share in cash in 2014.
How will it spend that cash?
Gabelli: It can buy back stock or make acquisitions. Thomas & Betts will be part of a global consolidation in the electrical-products market.
Crane [CR] makes aircraft components. There will be 33,000 commercial aircraft flying in the next 20 years. Some 14,000 planes will be taken out of the market, allowing for 30,000 to be built. Crane sells for 41.25. It has 58.9 million shares and the market cap is $2.5 billion. Net debt is $177 million. Revenue for 2010 will be about $2.2 billion, and Ebitda, $300 million. The company will earn $2.70 a share. [Crane reported last Monday that it earned $2.59 a share for the year.]
Next, I like a batch of wireless carriers. They are takeout plays. Millicom International Cellular [MICC] has done well since I recommended it a year ago. They have 35 million customers in Africa and Central and South America. There are 108 million shares and the stock is at 96. U.S. Cellular[USM] is another favorite. It is based in Chicago and serves six million customers. The stock is 50 and there are 86 million shares. Telephone and Data Systems [TDS] owns all but 15 million and should buy the balance.
Lastly, I'll recommend a gold stock.
Not you, too.
Gabelli: People in this room want physical gold available to them. How will it be transported? By Brink's [BCO]. There are 46 million shares, the stock is 27, the market cap is $1.3 billion. About 7% more currency has been put into circulation in the past five years. Brink's specializes in global logistics for the movement of precious metals and cash. There is another round of consolidation taking place in this business. Brink's will generate revenue of $3.6 billion in 2011, Ebitda of $330 million and earnings of $1.65 a share. Earnings could grow at a 17% annual rate in the next several years.
Thank you, Mario. Oscar, you've been very patient. Now tell us what you like.
Schafer: We invest thematically, but recently have found opportunities in companies that underwent leveraged buyouts and came public again. They share several characteristics. Management is accustomed to living with high levels of debt and cost-consciousness. These companies don't spend a lot of time figuring out which grand piano to put on the private plane. Also, they have low tax rates due to the stepped-up basis [readjustment of value] of the assets purchased in the LBO. So they have a lot of free cash flow to pay down their debt. They have a limited float [publicly traded shares], which restricts the number of big investors until a secondary offering occurs. Three of my recommendations fit this bill.
Sensata Technologies [ST] traces its origins back to 1916 and was acquired by Texas Instruments [TXN] in 1959. As part of TI, it grew into one of the leading sensor and control companies globally. However, TI didn't view it as a core business but as a reliable source of cash. This eventually led to an LBO of the business in April 2006. The LBO buyer sold a portion of its shares to the public last March, at 18. A secondary offering in November was priced at 24.10. Sensata is now 30.
What does Sensata do now?
Schafer: Sensors account for 60% of revenue. Controls are 40%. A sensor is a small device embedded into a larger system that measures physical signals, such as pressure, temperature, force or speed. It converts information into a signal that can be read by a computer. In a car, sensors measure all sorts of things, from tire pressure to fuel injection. Controls are high-end circuit breakers used in industrial equipment. They prevent overheating.
Sensata has had consistent high-single-digit revenue growth, with 30% Ebitda margins and 20% adjusted net-income margins, despite having such high exposure to the brutal auto-supply industry. Sensors cost $7 to $8, but the mission-critical function of these products and the potential for damage if one malfunctions insure that industry suppliers use sensors from manufacturers with a long history of near-perfect reliability. This has given Sensata a substantial market share in its market segment, and the ability to at least maintain pricing. Components using sensors generally are designed three years before a car is sold, giving Sensata good visibility on its pipeline and future revenue. The business has high barriers to entry, and recent changes in emissions, efficiency and safety standards are driving a meaningful increase in auto-sensor content per vehicle.
Does the company sell its products worldwide?
Schafer: Yes. In North America auto-sensor content averages $20 to $25 a vehicle. We expect the dollar amount to increase 7% to 8% annually as a lot of midrange cars adopt the standards used in high-end cars today. Sensor content in China averages around $10 a vehicle but is growing rapidly as China ratchets up its standards to be more in line with Western standards. Sensata can grow its business by 10% a year for the next three years. If auto sales continue to recover, that will be additive. The controls business is driven by the adoption in developing markets of durable goods such as refrigerators and washing machines.
Looking out, earnings growth will come more from double-digit top-line growth than margin expansion, although profits will be enhanced as the company continues to pay down the LBO debt.
How much debt does Sensata have?
Schafer: It has $2.2 billion. It earns three times what it pays in interest. The market cap is $5.4 billion.
Witmer: There isn't much book value, but the stock has a lot of earnings support. It has really amazing management.
Schafer: Sensata also has a pipeline of potential deals, as large companies look to divest pieces, including sensor businesses. Last October Sensata announced it was buying Honeywell's [HON] sensor business for one times revenue and, after synergies, four times Ebitda. Deals like this can add six to 20 cents a share to the bottom line relatively quickly. A business that generates $2 a share in earnings and could earn in the mid-$2-plus range in 2012 is worth more than 40 a share.
Jennifer Altman for Barron's
Oscar Schafer
NXP Semiconductors [NXPI], a spinoff from Philips Electronics[PHG]. The company is based in Holland. It was taken private by a consortium of private-equity firms in August 2006 and brought public again in August 2010 at 14. While private, NXP rid itself of many of the more commodity-centric pieces of its business. It emerged from its LBO as a maker of high-performance mixed-signal solutions and semiconductor components. It sells into end markets such as automotive, identification and lighting. Analog-semiconductor companies like NXP typically have 30% operating margins and a 5% to 7% capital-intensity [capital expenditures divided by revenue] versus digital companies, which are in the high teens. The new NXP produces 65 billion units annually.
What is the stock price?
Schafer: NXP is trading for 22.92. As the analog portion of the business increases to 75% of revenue in 2012 from 60% in 2010, margins will expand. Gross margins can increase a thousand basis points, to north of 50%. Secondly, NXP went private with a lot of leverage. Given its high margins, low capex [capital-spending requirements] and low tax rate, however, it generates a lot of free cash flow. It will reduce its leverage and interest expense significantly in the next two years. Interest expense could decline from $1.30 a share in 2010 to below a dollar in 2012.
Finally, there are interesting revenue opportunities that should enable meaningful growth. Notably, NXP is the critical standard for near-field communications. It is the market-share leader in electronic passports, transit cards and other contact-list forms of identification. In early December, Google[GOOG] announced it was designing the NXP standard into its latest Android platform in order to drive its vision of the digital wallet. Your cellphone will become your credit card. Shoppers will be able to hold their smartphones next to electronic readers at retailers and transit points, in restaurants and so forth. This could be a large incremental opportunity for NXP. Analysts' earnings estimates for NXP are in the $2.50 range for 2011 and $3 for 2012. The stock is trading at a single-digit P/E.
Black: What is the barrier to entry? A lot of people are making mixed-signal devices.
Hickey: Everyone has been trying to move into the analog business because the margins are better. It is getting overcrowded.
Schafer: Near-field communication eventually will be in a broad array of wireless chips. In the near term, NXP will benefit.
My third post-LBO stock is Hertz Global Holdings [HTZ]. Improving fundamentals in the car-rental industry and company-specific initiatives should enable strong revenue and earnings growth in the next two years, which isn't reflected in the current valuation of the stock. Hertz was bought from Ford [F] and taken private in 2005, and it went public again in 2006. Historically the car-rental industry has been plagued by periods of over-fleeting and aggressive price wars. Over-fleeting was caused in part by auto manufacturers' need to dump excess inventory, and large rental-car capacity led to aggressive pricing. During the recession, a number of factors positively impacted industry dynamics.
Such as?
Schafer: First, there has been consolidation. At this point there are only four major rental-car companies. The industry could be down to three players in 2011. Second, there was significant de-fleeting during the recession, so utilization is at about 80%, even at post-recession demand levels. The risk of fleet-dumping has been lessened for the next couple of years. Also, a dearth of auto leasing during the recession severely curtailed used-car supply, thus propping up residual values and lowering depreciation and costs for the rental companies. These factors, coupled with improving business in the leisure-travel market, should enable solid rental-car fundamentals for the foreseeable future.
Hertz has only 11% of the off-airport rental market, and it is severely under-represented in the value segment. Progress with its Advantage value brand could add a couple of points of growth in each of the next two years, on top of solid industry growth as travel recovers. Historically, the rental-car business grows at two times GDP. Also, 15% of Hertz's growth comes from the rental of industrial and earth-moving equipment. This business declined by more than 40% peak to trough. It is starting to improve and should grow by double digits in the next few years.
Give us some of the numbers on Hertz.
Schafer: Management is looking to sell certain properties to franchisees. That would significantly reduce the capital required by the business. Since 2007 Hertz has cut $1.7 billion in costs and is targeting another $300 million in 2011. Given operating leverage and this cost focus, Ebitda margins could rise from the mid-teens to more than 20% in the next few years. Earnings could approach $1.50 a share in 2012. Hence, the stock, at 14.39, is trading at less than 10 times 2012 estimates. Using a multiple of 15 times earnings, Hertz shares could rise to the 20s. Any further industry consolidation would be positive. The Federal Trade Commission is currently reviewing a merger ofAvis Budget Group [CAR] and Dollar Thrifty Automotive Group[DTG].
What do you think, Mario? Would you buy Hertz?
Gabelli: I own shares, but I haven't focused on it. I've been focused on the Dollar Thrifty deal. Mark Frissora, Hertz's CEO, came over from Tenneco, where he did a great job. Ron Nelson, who runs Avis, is a savvy financial guy. So now you have two business guys in the industry who are motivated and have an interesting tailwind in terms of reduced car supply. There is no reason not to own Hertz if airport travel is picking up, because the company has made a conscious decision to raise rates and is willing to turn away people who won't pay them.
Oscar Schafer's Picks
| Price | |
| Company/Ticker | 1/7/2011 |
| Sensata Technologies Holding / ST | $30.47 |
| NXP Semiconductors / NXPI | 22.92 |
| Hertz Global Holdings / HTZ | 14.39 |
| Quantum / QTM | 4.3 |
| Mako Surgical / MAKO | 14.1 |
| Source: Bloomberg |
Schafer: Quantum [QTM] is a small-cap focused on enterprise-computing storage. It historically has been a leader in enterprise-tape backup, with a 30% market share. Through its 2006 acquisition of ADIC, it consolidated its tape market share. More important, it acquired the patents and know-how for two key emerging technologies -- data deduplication and heterogeneous file-management software. Quantum trades for 4.30, under 10 times my earnings estimate for fiscal 2012, ending March. [Shares fell sharply last week after Quantum reported disappointing quarterly earnings. In a follow-up conversation, Schafer said "transitions can often be bumpy but I believe in the company's long-term potential."] The market is overlooking some subtle but critical changes in the business mix. Revenue has been declining for three years, and the perception is this is a tape company with a perpetually declining revenue stream. However, two changes are impacting the revenue stream.
And they are?
Schafer: First, deduplication is growing rapidly and becoming a larger part of Quantum's revenue. The company has become No. 2 in the business to EMC[EMC]. Value-added resellers and other OEMs have been embracing Quantum as an alternative to EMC. Likewise, Quantum's file-management software business has been growing by north of 50%. Together these businesses are 20% of revenue and will become an increasingly important driver of revenue growth.
On the tape side, Oracle's [ORCL] recent acquisition of Sun Microsystems has created dislocation in the channel. As Oracle focuses more on direct sales, Quantum is gaining share in its branded-tape business. We expect Quantum to shift from being a company with a declining revenue stream to one with mid- to high-single-digit revenue growth and mid-teens operating margins. The market will reward the shift with multiple expansion. And, given aggressive consolidation in the storage space, we wouldn't be surprised to see strategic partners take note of the shift. The stock could have 50% to 100% upside from here.
What do you think, Fred?
Hickey: The tape-storage business is slowly dying, and there are more deduplication players than just EMC.
Schafer: My last pick, Mako Surgical [MAKO], has developed a robotic procedure and implants for hip and knee replacements. It is in the early stages of a multiyear product cycle. It currently markets partial knee replacements, and soon will launch a total-hip-replacement product, which is a much bigger market opportunity. The stock, now around 14, could hit the high-teens to low-20s in 12 months.
Mako is working to redefine orthopedic surgery by providing more precision and accuracy. I am excited about its near- and long-term prospects. For one, aging demographics could make for a robust low-double-digit growth rate for hip and knee replacements through 2015. Secondly, providing robotic joint surgery allows hospitals to differentiate themselves and increase patient volumes. The patients who get partial knee replacements tend to be younger and more likely to have higher-reimbursement commercial insurance rather than Medicare, which improves the revenue mix of these hospitals. Mako is conducting more than 50 clinical studies to demonstrate the superiority of robotic surgery.
How many hospitals have signed on?
Schafer: About 5% in medical centers that perform more than 150 knee replacements per year. With more than 300 patents covering Mako's technology, the barriers to entry are substantial. Finally, the company has enough cash until it becomes profitable by the end of next year or early 2013. This is a razor/razor-blade business that is common in the medical-device industry. The razor is an $850,000 robot and the blade is the $5,000 implant. The company has 67 robots in hospitals now, and conducted about 3,400 knee procedures last year. There are approximately 50,000 partial knee replacements per year.
The opportunity in hip replacements is six times larger. The hip indication also broadens the eligible surgeon pool. Many hip replacements fail because of misalignment of the implant in the hip. Using the robot ensures proper alignment and is expected to improve the success rate of these procedures.
There are some bears on the company. Short interest is 25% of the float. The shorts are concerned about the high upfront costs of the robot, and some also believe there is a lack of clinical data to support the superiority of Mako's system. There is some concern about Mako's valuation. The company is trading for around seven times 2011 and five times 2012 revenue. This premium multiple is warranted for the 50%-plus revenue growth we expect in the next few years. Two of the three founders of Intuitive Surgical [ISRG], the maker of the daVinci robot for prostate surgery, are on Mako's board. Intuitive has been one of the great stocks of the past five to seven years.
Black: This could be big competition for Zimmer [ZMH], Medtronic [MDT] and Stryker [SYK]. Are they working on their own products?
Schafer: Robotics won't take over the whole business.
Gabelli: I drink bourbon, Oscar. I test my products. You should have a hip done.
On that note, let's go to dinner. Thanks, everyone.
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