FootStar, Inc.

Footstar, Inc. (FTAR) is a holding company and operates a retail business through Meldisco, which sells family footwear through licensed footwear departments and wholesale arrangements. Meldisco has operated licensed footwear departments since 1961 and is the operator of licensed footwear departments in the United States. FootStar was forced into bankruptcy by a problematic athletic shoe division which was later sold off. In February, they emerged from Chapter 11, with no debt.

Valuation of FootStar must take into account two separate scenarios. Under the current Kmart Settlement, FootStar is set to be liquidated at the end of 2008. The liquidation would be the worst case scenario, however, it still represents an attractive proposition. In the two quarters out of bankruptcy, FootStar has reported $20 MM and $6 MM in earnings. Assuming a conservative run-rate of $40 MM per year and $5 MM adjustment for D&A, FootStar will have accumulated an additional $90 MM in cash through 2008. On the balance sheet, FootStar has $68 MM in cash, $110 MM in inventory, a $20 MM headquarters building with an additional $135 MM in liabilities. FootStar could be worth approximately $153 MM at liquidation with some additional upside for their NOL's.

If FootStar is allowed to continue as ongoing concern past 2008, then we assume $40 MM annual earnings, or $60 MM of EBITDA and look at peer comparisons. With an industry P/E multiple average of 14 and EV/EBITDA average of 8 and the existing $68MM cash, this implies FootStar is worth between $548-628 MM.

Given 21 MM shares outstanding, we have approximately $7.28 per share in liquidation value and approximately $26-30 per share if FootStar continues to operate. I was lucky enough to purchase shares in February at $4.20 and October at $4.93 which represented a large enough discount to the worst case scenario. The shares have moved up substantially since then to the current price of $6.60. This currently only represents a small discount to liquidation, and I am not sure if I would recommend a purchase. However, I continue to hold as a free call on the possibility that they are an ongoing concern, either through renegotiation of KMart Agreement or pursuit of a different business model.

Additional Opinions:

• George Schultze
• Whitney Tilson