Recent Thoughts on FTAR

I had to present an investment idea for class today, and I didn't have one readily available so I decided to update one of my current ideas that I am waiting to play out. Not much has changed with the overall thesis, but it's always good to revisit.

For the price of $90 M, you get the shoe department operator for Kmart. The interesting twist is the Kmart Agreement, which stipulates that this contract will end in 2008. Afterwards, we consider a liquidation scenario and an ongoing-concern scenario.

As of Q3 2007, here is how I would judge the tangible book value to shareholders ($M)

Cash.............................16
Receivables......................9
Inventory......................107
PP&E............................22
Assets.........................154

Liabilities.....................113

Tangible SE....................41

As part of the earlier Agreement, Kmart has agreed to purchase FTAR's inventory at book value at the end of 2008, so I count that as good as cash. The PP&E consists mostly of their NJ headquarters building, so I feel that there should not be heavy discounting in its value. Their Annual Report should be out sometime soon, but in absence of that, I estimate their earnings will be $20 M for Q4 2007 and $40 M for FY 2008. Adding that all up, they should be worth approximately $100 M at the end of this year. Very little upside, but good downside protection.

The interesting twist is if they renew their contract with Kmart. I'd assume $40 M annual earnings, and with a conservative 10X multiple, they could be worth $400 M. I don't know how to ascertain the probability of that happening, but we basically have a free option on that scenario.

I was originally attracted to the sizable cash position of this company, trading at a 10-20% premium to net cash. However, last year they elected to do the right thing and declare a special $5 dividend, which effectively took my money off the table. I thought about it some more and actually decided that the company became more attractive post-dividend as opposed to pre-dividend.

The reason being is that declaration of the dividend served effectively as a recapitalization of the company, and levered the possible returns. It's very similar to the risk-reward situation of buying at-the-the money calls versus deep in-the-money calls.


As we can see in this diagram, in the 1st situation we buy an asset for $15 with the belief that it is worth $20. That gives us $5 of upside, which translates into a 33% gain. If that company were to shed $10 of excess assets, cash, etc., and we retained the original upside, then we would have a $5 asset with $5 of upside, for a 100% gain. Our benefit is derived from reducing the amount of initial committed capital.

"Are stocks pieces of paper to be endlessly traded back and forth, or are they proportional interests in underlying businesses? A liquidation settles this debate, distributing to owners of pieces of paper the actual cash proceeds resulting from the sale of corporate assets to the highest bidder.”

-- Seth Klarman, "Margin of Safety"