Monday, March 10, 2014

Special Situation Ideas for week of 10-MAR-2014

URS (NYSE: URS): This is an interesting time to take a look at a company, that’s a play on US and internal infrastructure. The company operates in 4 major sectors – Government (roads, bridges, water infrastructure, nuclear, among others); Oil & Gas, Power and Industrial. The firm has underperformed its peeps for a while, however, the firm does not look like it’s badly managed.
The company trades at 11x earnings, with a 1.9% yield. I believe that this and next year should see capital spending, especially on infrastructure and capital spending, especially on Industrial, and Oil & Gas sectors should pick up in the next two years.
Another interesting thing that has happened in the last month, is the involvement of some very well-known hedge funds in this business, among them Jana Partners, which has declared a 9.9% stake in the company at an average cost of $47.46 per share. Jana Partners is having discussions with the company regarding capital and corporate structure. March 14 is the new deadline for submitting director nominations. This deal is a little different from the usual activist situation for Jana; it started out as a passive 13G investment that was converted to a 13D after the company announced poor financial results. For now, it's an amicable engagement, with the company agreeing to extend the deadline for stockholders to nominate directors so it can continue negotiations with Jana. Despite generating $1.5bn of FCF and completing $5.3bn of acquisitions since 2006, the company has grown its EV by only $2.5bn. These acquisitions left the company with many separate businesses that haven't been integrated, and with strong cash flow significantly in excess of earnings. So, the activist opportunities here are to use free cash flow to buy back stock, divest some of the businesses that haven't been working out, and/or take advantage of the FCF to sell the entire company or do a leveraged buyout. Because URS' long-time chairman/CEO is expected to retire this year, and his logical successor recently resigned, now is likely a good time to proceed, since activist agendas are much easier to implement when the management team is in transition.

Chemtura (CHMT):
This is a FY10 post-bankruptcy play. The firm filed for bankruptcy pressured by rising raw material costs and declining sales. It eventually emerged in FY10 with a liquidation value of $750M. It had 4 segments, Consumer division, and Industrial Performance Product (IPP), Industrial Engineering Product (IEP), and Agricultural division.  Recently, the firm got out of consumer unit, by selling it for USD 315M.  The company is in the process of selling its agricultural unit, which is expected to be sold around $800M - $1bn.
The company has discussed using the cash from divestitures, to return it to shareholders and deleverage the balance sheet. The company is expect to generate FCF of $72M In in FY14, and currently has net debt of approx. $350M, with $550M in cash.
The firm has been going through some major restructuring and cost reductions since FY10, that are expected to bear fruit in FY14.  In addition, IEP unit, which has been the most problematic is expected to have hit a bottom is should begin to improve going forward. The IEP+IPP division generated $310M in EBITDA and I expect them to generate $282M this year and improve going forward. Agro solutions generates about $75M in EBITDA.  At 8x EBITDA, I believe that investors get agriculture division for free, if they can buy this company at $25 range. The stock can easily be valued at more than $35, in a year. The kicker is the management. The CEO of CHMT was appointed by the Debtors committee, and is the former CEO of Hercules. He was instrumental in the sale of the company to Ashland in FY08.  

BroadRidge Financial (BR):
Given the current market environment, everything thinks about investing in such a firm that would largely remain unaffected by the daily gyrations that markets go through. I recommend to look at BR. BR is a service company that provides trade processing and Investor communications business to the financial service industry. It services 4 major clients, mutual funds, Corporates, Banks and broker dealers. The firm controls 90% of the proxy market, approx. 33% of equity processing and 55% fixed income processing market in the US. There are huge regulatory hurdles to enter and compete with BR, putting it in a good position. Additionally, the company is technologically savvy and disruptor in the space. It also is helping its clients save cost (eg: it does fixed income processing for its clients at 25% cheaper cost than institutions can do internally).  Since it’s the leading firm in the US, its innovation should only produce modest growth. Its also going into buy side, a new area for BR.
The kicker comes from its recently announced JV with Accenture, to scale its capabilities and products into Europe and Asia. With its credibility already working for Major US institutions, it should not have trouble cracking those markets and providing the next leg up in terms of revenue generation and profits. It already counts SocGen as its client and is growing in Europe. BR comes with a solid balance sheet. It has $300m of net debt and approx. $300M of FCF. The firm sports a 2.2% dividend yield and trades at 17x earnings. It stands to benefit, as major banks and broker dealers cut costs and look for a credible partner to provide them with the same quality services and BR might just prove to be that. If it continues to execute, BR stock can easily be $50+ in 1 to 1.5yrs.

GameStop (GME):  After reporting weak sales of videogames during the holiday season, GME fell 18% to $37.50. The market reaction creates an opportunity for investors. The shares now trade for 10x FY14 earnings. Plus, the company has $5 a share in cash on its balance sheet and no debt. The stock yields 3%, and last year the company bought back 7% of its shares. GME has no debt on the balance sheet, healthy cash flow and sports a 3% dividend yield. GME remains the dominant seller of videogames, with a roughly 50% market share, and sits at the center of a lucrative ecosystem involving new and used games. GME's sales of new-game hardware nearly doubled during the holiday period as Sony introduced its new PS4 and Microsoft rolled out its Xbox One. Software sales, however, fell 22.5%, which GME attributed to reduced sales of games for the older Sony and Microsoft consoles, but the Street worried that the report signaled a slide in the disc portion of the business. One reason that software sales might have been weak is that consumers bought millions of new PS4s and Xbox Ones—which cost $399 and $499, respectively—leaving little money to spare for new games, which usually cost about $60 apiece. Given the high upfront investment, new-game sales may follow. However, there seems to be a strong pipeline of games in FY14 and FY15. According to some industry estimates, this stock can be valued at $55 to $60 a share on modest new and used software sales growth and flat hardware sales.  

Insulet Corporation (PODD):
Insulet (PODD), an insulin-device maker that has risen 130% over 2yrs. But there is a problem – PODD is a one-trick pony, selling OmniPod and has yet to make a profit since 2005, the time it had the tubeless-pump market pretty much to itself. There are other big companies with deeper pockets, such as Medtronic (MDT) and Roche Holding (ROG). There are about 1.5 million to 1.7m Americans with Type 1 diabetes, of which 25%-30% use some kind of pump, rather than manual injections. Medtronic has been talking about a "patch pump" for a while, but investors should pay attention to the September settlement that terminated its patent-infringement lawsuit against Insulet. PODD can use some patents of Medtronic but in return, Medtronic is licensed to use some of PODD’s, including the one for automatic needle insertion, an important OmniPod feature. The settlement precludes Medtronic from making a replica of the OmniPod, but doesn't stop it from producing a similar product—that is, a wearable, disposable tubeless pump with automatic needle insertion. Profit expected by 2014 and 2015. This company might make a good short.

Personal Note: I am long, CHMT, URS, GME and BR.