Dear Readers,
We would like to thank our loyal readership of the past few months and years. This year has provided Stock Research many milestones and we would like to thank you for allowing us to achieve them. First, we have had over 2,200 views of our blog since June 2007. Second, our articles have been published on Seeking Alpha and Yahoo! Finance quite an accomplishment for a novice investor. Our blog has been viewed by people on every continent except Antarctica. Another accomplishment is that we have a reader in every state except Maine. Lastly, we would like to inform you that our musings will now be on permanent hiatus.
On September 24, 2007, your writer, editor, and stock picker extraordinaire accepted a position with Stifel Nicolaus as an Associate in Equity Research covering Internet Consumer Services companies. I would recommend hiring a broker with access to Stifel research, or opening an account at Stifel, if you wish to continue to read my thoughts. My new position will preclude me from writing anything for this blog.
I hope that my story serves as encouragement for some of my fellow bloggers. I created the blog in order to build a portfolio of writing samples and a chain of investment thought. The purpose was to quantify my skills for a prospective employer in the financial services industry. With the acceptance of my new job, the blog reached its telos - Plato would be proud.
As I sign off, I would like to leave you all with some advice and observations of the cottage industry that is financial blogging. Seeking Alpha seems to be a popular website and does an admirable job of providing financial content. The problem is that if they wish to monetize their product, editors must do a better job of vetting articles. The recent turmoil in credit markets seems has given rise to numerous bloggers with investment advice about troubled companies. Many authors are failing to fully disclose their conflicts of interest about the stock about which they write.
Lastly, writers need to take their research to the next level. A major problem with financial blogging is that the majority fail to take the time to develop a concrete empirically supported investment thesis. Anyone can put in writing that a company will not go bankrupt or is undervalued; if you claim to be a financial blogger / researcher you need to provide data to support such arguments. I challenge the blogging community to pick up where I leave off. That point of departure is providing readers with concrete valuations and numerical tests to support an investment thesis.
As I write this letter I am filled with bittersweet feelings. I am elated that I am embarking upon a professional equity research career. Indeed, getting here has been a long and arduous journey. My saddness lies in the fact that I must no longer write for my blog. Financial blogging has a bright future which begs the question how do we monetize the industry?
Again, thank you all for reading and I hope that you gained some good insights and enjoyed my writing. I hope that financial bloggers will take up the challenge I issue above.
To show that I have a sense of humor my associate Louis Entsminger gives everyone a meow of thanks. He is my girlfriends cat.
Sincerely,
Steve Rubis
stevenrubis@yahoo.com
Thursday, November 15, 2007
Sunday, August 05, 2007
Valuation Analysis of China 3C Group (CHCG.OB)
By: Steve Rubis
Recommendation: UNDERVALUED
China 3C Group is a distributor which operates using a “store in store” concept in Eastern China. Based on company guidance of $1B in revenue by 2010, the company is worth $16.38 per share using a discounted cash flow valuation.
Investment Thesis:
China 3C Group combines two of the most powerful catalysts for share price appreciation: earnings growth and China. CHCG expects to operate 4,000 stores and generate revenue of $1B by the year 2010. If the company meets these expectations, revenue will grow at a 61% rate. China 3C Group trades at a discount for two reasons: (1) the stock is listed on the OTC Bulletin Board; and, (2) being based in China creates a dearth of information on the company.
Catalysts:
1.) AMEX listing: China 3C Group applied for listing on the American Stock Exchange on January 15, 2007. Listing on the AMEX would supply greater prestige for CHCG. Such prestige would generate share price appreciation because such a listing would increase investor familiarity.
2.) Information: once the company is listed on the AMEX, more information on the company should be readily available. This will help determine whether growth estimates are realistic or blue sky estimates.
3.) Chinese Economy: currently, China is experiencing unprecedented economic growth. If a recession were to hit the Chinese Economy, CHCG would be adversely affected.
Valuation:
The discounted cash flow method of valuation works best in analyzing China 3C Group. Relative analysis is nearly impossible due to difficulty in determining what industry CHCG belongs to and who its competitors are.
Table 1: DCF Valuation of China 3C Group Using Company Guidance
The table above illustrates the value of China 3C Group using management estimates for growth over the next four years. Management committed to operating 4,000 stores and generating $1B in revenue by 2010. This guidance suggests a 61% rate of growth, which can be calculated using the rate function in Microsoft Excel, or any financial calculator. The model assumes a more modest rate of growth, roughly 17%, for the years 2011 through 2016. Our model assumes a risk free rate of 7% and an unlevered beta of 2. These assumptions take into account default risks associated with foreign markets, and the volatility of equity prices for companies listed on the OTCBB.
Table 2: DCF Valuation of China 3C Group Using Conservative Growth Estimates
Table two illustrates what CHCG is worth using more conservative growth estimates. This DCF model assumes a 17% rate of growth well below the 61% in our first model. The model in table two assumes a risk free rate of 7% due to default risks associated with foreign investments and an unlevered beta of 1, since the model uses a more conservative growth estimate.
Table 3: Relative and Other Valuation Methods
The relative valuation presented in table three uses the electronic stores industry for industry averages. China 3C group does not perform favorable using these valuation methods. From a P/E perspective CHCG is undervalued, but the stock trades at a premium in terms of price to sales and price to book value. These values as well as earnings power value are misleading because the company expects to achieve exponential growth over the next few years. Values presented in table three are interesting but do not provide an adequate assessment of the investment opportunity in China 3C group.
Business Prospects / model:
China 3C Group is a consumer electronics distributor, which operates nearly 800 stores in mainland China. The company distributes mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, and audio systems. China 3C Group expects to see strong growth from the mobile phone market over the next few years. The company has committed to operating 4,000 stores that generate $1B in revenue by 2010 (see company website).
In 2006, CHCG saw strong organic sales growth from its YYWC and HWDA subsidiaries. Each subsidiary grew revenues by 122% and 480% respectively. The company utilizes an acquisition strategy to compliment its organic growth of existing subsidiaries. CHCG acquired Hangzhou Sanhe Electronic Technology, Limited and Shanghai Joy and Harmony Electronic Development Co., Ltd. These newly acquired subsidiaries contributed $35M in revenue to CHCG in 2006.
The following chart describes the structure of China 3C Group’s subsidiaries.
Chart 1: Operating Structure of China 3C Group and Subsidiaries
Special Circumstances:
Equity Private Placement
Some analysts believe that the recent private placement of equity in CHCG raises red flags. Shares were sold at a discount to current prices, $5.60 per share, which we find reasonable. Such a discount is to be expected because CHCG trades on the OTC Bulletin Board. If the company were listed on the AMEX or NASDAQ, such a discount would be questionable. The discount represents the liquidity risk that the investor undertakes by providing capital to an OTC BB stock.
Best Buy (BBY) Agreement
This Forbes articles gives investors confirmation that China 3C Group might be a legitimate company. Best Buy came to an agreement with CHCG to provide consumer electronics goods for Best Buy’s new store in Shanghai.
*CHCG is a highly speculative investment because of its listing on the OTCBB exchange. The company's location in mainland China makes it difficult to verify and obtain information on the company. The author cannot be held responsible for any monies gained or lost on trades undertaken based on information presented herein. The author currently owns: Agilent Technologies (A), Brasil Telecom S.A. (BRP), Biotel, Inc. (BTEL.OB), ChipMOS Technologies Limited (IMOS), and ConocoPhillips (COP).
Recommendation: UNDERVALUED
China 3C Group is a distributor which operates using a “store in store” concept in Eastern China. Based on company guidance of $1B in revenue by 2010, the company is worth $16.38 per share using a discounted cash flow valuation.
Investment Thesis:
China 3C Group combines two of the most powerful catalysts for share price appreciation: earnings growth and China. CHCG expects to operate 4,000 stores and generate revenue of $1B by the year 2010. If the company meets these expectations, revenue will grow at a 61% rate. China 3C Group trades at a discount for two reasons: (1) the stock is listed on the OTC Bulletin Board; and, (2) being based in China creates a dearth of information on the company.
Catalysts:
1.) AMEX listing: China 3C Group applied for listing on the American Stock Exchange on January 15, 2007. Listing on the AMEX would supply greater prestige for CHCG. Such prestige would generate share price appreciation because such a listing would increase investor familiarity.
2.) Information: once the company is listed on the AMEX, more information on the company should be readily available. This will help determine whether growth estimates are realistic or blue sky estimates.
3.) Chinese Economy: currently, China is experiencing unprecedented economic growth. If a recession were to hit the Chinese Economy, CHCG would be adversely affected.
Valuation:
The discounted cash flow method of valuation works best in analyzing China 3C Group. Relative analysis is nearly impossible due to difficulty in determining what industry CHCG belongs to and who its competitors are.
Table 1: DCF Valuation of China 3C Group Using Company Guidance
The table above illustrates the value of China 3C Group using management estimates for growth over the next four years. Management committed to operating 4,000 stores and generating $1B in revenue by 2010. This guidance suggests a 61% rate of growth, which can be calculated using the rate function in Microsoft Excel, or any financial calculator. The model assumes a more modest rate of growth, roughly 17%, for the years 2011 through 2016. Our model assumes a risk free rate of 7% and an unlevered beta of 2. These assumptions take into account default risks associated with foreign markets, and the volatility of equity prices for companies listed on the OTCBB.
Table 2: DCF Valuation of China 3C Group Using Conservative Growth Estimates
Table two illustrates what CHCG is worth using more conservative growth estimates. This DCF model assumes a 17% rate of growth well below the 61% in our first model. The model in table two assumes a risk free rate of 7% due to default risks associated with foreign investments and an unlevered beta of 1, since the model uses a more conservative growth estimate.
Table 3: Relative and Other Valuation Methods
The relative valuation presented in table three uses the electronic stores industry for industry averages. China 3C group does not perform favorable using these valuation methods. From a P/E perspective CHCG is undervalued, but the stock trades at a premium in terms of price to sales and price to book value. These values as well as earnings power value are misleading because the company expects to achieve exponential growth over the next few years. Values presented in table three are interesting but do not provide an adequate assessment of the investment opportunity in China 3C group.
Business Prospects / model:
China 3C Group is a consumer electronics distributor, which operates nearly 800 stores in mainland China. The company distributes mobile phones, facsimile machines, DVD players, stereos, speakers, MP3 and MP4 players, iPods, electronic dictionaries, CD players, radios, Walkmans, and audio systems. China 3C Group expects to see strong growth from the mobile phone market over the next few years. The company has committed to operating 4,000 stores that generate $1B in revenue by 2010 (see company website).
In 2006, CHCG saw strong organic sales growth from its YYWC and HWDA subsidiaries. Each subsidiary grew revenues by 122% and 480% respectively. The company utilizes an acquisition strategy to compliment its organic growth of existing subsidiaries. CHCG acquired Hangzhou Sanhe Electronic Technology, Limited and Shanghai Joy and Harmony Electronic Development Co., Ltd. These newly acquired subsidiaries contributed $35M in revenue to CHCG in 2006.
The following chart describes the structure of China 3C Group’s subsidiaries.
Chart 1: Operating Structure of China 3C Group and Subsidiaries
Special Circumstances:
Equity Private Placement
Some analysts believe that the recent private placement of equity in CHCG raises red flags. Shares were sold at a discount to current prices, $5.60 per share, which we find reasonable. Such a discount is to be expected because CHCG trades on the OTC Bulletin Board. If the company were listed on the AMEX or NASDAQ, such a discount would be questionable. The discount represents the liquidity risk that the investor undertakes by providing capital to an OTC BB stock.
Best Buy (BBY) Agreement
This Forbes articles gives investors confirmation that China 3C Group might be a legitimate company. Best Buy came to an agreement with CHCG to provide consumer electronics goods for Best Buy’s new store in Shanghai.
*CHCG is a highly speculative investment because of its listing on the OTCBB exchange. The company's location in mainland China makes it difficult to verify and obtain information on the company. The author cannot be held responsible for any monies gained or lost on trades undertaken based on information presented herein. The author currently owns: Agilent Technologies (A), Brasil Telecom S.A. (BRP), Biotel, Inc. (BTEL.OB), ChipMOS Technologies Limited (IMOS), and ConocoPhillips (COP).
Wednesday, August 01, 2007
ChipMOS Technologies (Bermuda) Ltd.
By: Steve Rubis
Recommendation: UNDERVALUED
Taiwanese semiconductor manufacturer with a depression valuation offers investors a strong upside with small downside risk. In terms of valuation alone, ChipMOS Tech Bermuda trades at a deep discount, all valuation methods confirm this thesis.
Investment Thesis:
ChipMOS Tech Bermuda seems to be undervalued due to a lack of investor familiarity, possibility of financial distress, a convoluted ownership structure, legal issues, and lack of diversification among customers. The following issues are reflected in the current price:
1.) Ownership: 50% of shares outstanding were owned by other semiconductor companies.
2.) Customer Concentration: 52% of revenues were generated by three customers in the previous year.
3.) Legal Issues: Shih-Jye Cheng, CEO, has been indicted by the Taiwanese Government for inappropriate use of company funds.
4.) Geo-political risk: ChipMOS operates in Taiwan with significant exposure in China. This exposes the company to significant political risk, given the less than friendly relations between Taiwan and China.
Competitors:
Advanced Semiconductor Engineering, Inc. (ASX)
Amkor Technology, Inc. (AMKR)
ASAT Limited
ASE Test Limited
International Semiconductor Technology, Ltd.
King Yuan Electronics Co., Ltd.
Powertech Technology, Inc.
Siliconware Precision (SPIL)
STATS ChipPAC Ltd. (STTS)
United Test and Assembly Center Ltd.
Valuation:
Investors should find IMOS attractive because the company seems undervalued in terms of numerous valuation methodologies. The analysis below will illustrate ChipMOS Technology Bermuda’s value in terms of the following methods: free cash flow, take out value, relative valuation, earnings power value, and reproduction value. In order to provide a thorough valuation analysis, we will provide a comparison of IMOS to its competitors as well.
Table 1: Discounted Cash Flow Valuation for ChipMOS Technology Bermuda (IMOS)
The discounted cash flow valuation in table one supports our undervaluation theory. Returns on capital are well above the weighted average cost of capital resulting in a positive margin of 5.2%. Reinvestment rates are quite high, but this yields a very high growth rate of 38%. Unfortunately, the majority of IMOS’s value in this DCF is derived from the terminal value. Investors might find this problematic; nevertheless, the company still seems to offer investors a more than reasonable margin of safety. In other words, current values account for this issue.
Table 2: Valuation Data for ChipMOS Techology Bermuda (IMOS)
Comparing IMOS’s metrics to the Semiconductor Equipment Industry offers investors a compelling argument for investment. The chart above shows that IMOS seems to be worth at least $4 more than its current price. First, Price and Enterprise Value to EBITDA values are incredibly low, suggesting the company could be attractive to a “fabless” or other semiconductor manufacturing companies. The current value of IMOS from a relative perspective suggests investors believe that IMOS will encounter some sort of financial distress. Each valuation offers a significant margin of safety
Table 3: Relative Valuation of IMOS in Terms of Competitors
Table three compares IMOS to those companies it lists as competitors in its annual 20-F report. This comparison once again suggests that IMOS is undervalued and offers a significant margin of safety. Furthermore, the comparison suggests that investors might be well served in analyzing Advanced Semiconductor Engineering, Inc. (ASX) as well.
Business Prospects / model:
ChipMOS Technologies Bermuda is a holding company with investments in the following semiconductor businesses: ChipMOS Technologies Ltd. (Hong Kong); ChipMOS Technologies Inc. (Taiwan), which owns 35.6% of ThaiLin Semiconductor Corp. (Taiwan); and, Modern Mind Technology Limited, which owns 100% of ChipMOS Technologies Ltd. (Shanghai, PRC).
Table 4: Company Structure as Presented in 20-F Report
The company’s semiconductor holdings make IMOS an independent provider of semiconductor testing and assembly, meaning the company focuses on back end semiconductor manufacturing. They are a global leader in LCD and flat panel display testing and assembly, and a leader in the Taiwanese market for advanced memory products.
As of Monday, Mosel Vitelic, Silicon Precisionware, and Highbridge Holdings accounted for 51.5% of the shares outstanding. This seems to have been a drag on possible movements to the upside. In an interesting move, Mosel Vitelic lowered its position in IMOS by nearly 10% on Monday.
Mosel Vitelic, Inc. Sells Stake in IMOS
The interesting part of this story is that Mosel liquidated 10% of its position for $6.30 per share, for a total loss of $47.9M New Taiwanese Dollars. The sale should not have a dilutive effect, since ProMOS Technology, Inc. and Powertech Technology, Inc. each purchased Mosel's 10% position.
Special Circumstances:
Investors should pay special attention to page 25 of the annual 20-F report for IMOS. The annual report gives a comprehensive discussion of the trends in semiconductor manufacturing, which we will attempt to summarize / paraphrase now.
IMOS discusses the current trends in the semiconductor manufacturing industry and argues that these trends are responsible for company growth. Simply, the majority of semiconductor manufacturers have started to outsource the production, back-end services, of semiconductors. As semiconductor companies become “fabless” companies like IMOS receive more business.
They identify three key trends for this shift to outsourcing:
1.) Significant Capital Expenditure Requirement: complex structures and shorter product life spans makes it more economically efficient for semiconductor companies to outsource the fabrication and testing of semiconductors. Outsourcing allows the major companies to share the risks of a possible downturn in the industry
2.) Increasing Focus on Core Competencies: simply, the increasing expenses associated with fabrication makes forces companies to focus on design, while outsourcing fabrication.
3.) Time-to-Market Pressure: shorter product life spans force companies to outsource production
IMOS also provides an answer why these trends are pertinent to the company:
Outsourcing in Taiwan and China:
Taiwan is a leading global market for outsourcing of semiconductor fabrication and testing. Most companies focus on a specific part of the fabrication and testing process, resulting in economies of scale, higher utilization rates, and greater flexibility. Lastly, the proximity of China and Taiwan allows for greater economies of scale and quicker production times, since all companies are based in the same general geographic location.
I hold a 400 share position in ChipMOS Tech Bermuda, and in order to quell any conflict of interest concerns, here are a few articles that support our research:
Smart Money on IMOS
Motley Fool's Take on IMOS
Forbes on IMOS
Regardless of my views on ChipMOS Tech Bermuda, many media outlets seem to believe that the company is undervalued.
Disclaimer: The author cannot be held responsible for any monies gained or lost from trades undertaken based on information presented herein. The author currently owns the following stocks: 400 shares of IMOS at $6.90.; Agilent Technologies, Inc. (A); Brasil Telecom S.A. (BRP); ConocoPhillips (COP), Biotel, Inc. (BTEL).
Recommendation: UNDERVALUED
Taiwanese semiconductor manufacturer with a depression valuation offers investors a strong upside with small downside risk. In terms of valuation alone, ChipMOS Tech Bermuda trades at a deep discount, all valuation methods confirm this thesis.
Investment Thesis:
ChipMOS Tech Bermuda seems to be undervalued due to a lack of investor familiarity, possibility of financial distress, a convoluted ownership structure, legal issues, and lack of diversification among customers. The following issues are reflected in the current price:
1.) Ownership: 50% of shares outstanding were owned by other semiconductor companies.
2.) Customer Concentration: 52% of revenues were generated by three customers in the previous year.
3.) Legal Issues: Shih-Jye Cheng, CEO, has been indicted by the Taiwanese Government for inappropriate use of company funds.
4.) Geo-political risk: ChipMOS operates in Taiwan with significant exposure in China. This exposes the company to significant political risk, given the less than friendly relations between Taiwan and China.
Competitors:
Advanced Semiconductor Engineering, Inc. (ASX)
Amkor Technology, Inc. (AMKR)
ASAT Limited
ASE Test Limited
International Semiconductor Technology, Ltd.
King Yuan Electronics Co., Ltd.
Powertech Technology, Inc.
Siliconware Precision (SPIL)
STATS ChipPAC Ltd. (STTS)
United Test and Assembly Center Ltd.
Valuation:
Investors should find IMOS attractive because the company seems undervalued in terms of numerous valuation methodologies. The analysis below will illustrate ChipMOS Technology Bermuda’s value in terms of the following methods: free cash flow, take out value, relative valuation, earnings power value, and reproduction value. In order to provide a thorough valuation analysis, we will provide a comparison of IMOS to its competitors as well.
Table 1: Discounted Cash Flow Valuation for ChipMOS Technology Bermuda (IMOS)
The discounted cash flow valuation in table one supports our undervaluation theory. Returns on capital are well above the weighted average cost of capital resulting in a positive margin of 5.2%. Reinvestment rates are quite high, but this yields a very high growth rate of 38%. Unfortunately, the majority of IMOS’s value in this DCF is derived from the terminal value. Investors might find this problematic; nevertheless, the company still seems to offer investors a more than reasonable margin of safety. In other words, current values account for this issue.
Table 2: Valuation Data for ChipMOS Techology Bermuda (IMOS)
Comparing IMOS’s metrics to the Semiconductor Equipment Industry offers investors a compelling argument for investment. The chart above shows that IMOS seems to be worth at least $4 more than its current price. First, Price and Enterprise Value to EBITDA values are incredibly low, suggesting the company could be attractive to a “fabless” or other semiconductor manufacturing companies. The current value of IMOS from a relative perspective suggests investors believe that IMOS will encounter some sort of financial distress. Each valuation offers a significant margin of safety
Table 3: Relative Valuation of IMOS in Terms of Competitors
Table three compares IMOS to those companies it lists as competitors in its annual 20-F report. This comparison once again suggests that IMOS is undervalued and offers a significant margin of safety. Furthermore, the comparison suggests that investors might be well served in analyzing Advanced Semiconductor Engineering, Inc. (ASX) as well.
Business Prospects / model:
ChipMOS Technologies Bermuda is a holding company with investments in the following semiconductor businesses: ChipMOS Technologies Ltd. (Hong Kong); ChipMOS Technologies Inc. (Taiwan), which owns 35.6% of ThaiLin Semiconductor Corp. (Taiwan); and, Modern Mind Technology Limited, which owns 100% of ChipMOS Technologies Ltd. (Shanghai, PRC).
Table 4: Company Structure as Presented in 20-F Report
The company’s semiconductor holdings make IMOS an independent provider of semiconductor testing and assembly, meaning the company focuses on back end semiconductor manufacturing. They are a global leader in LCD and flat panel display testing and assembly, and a leader in the Taiwanese market for advanced memory products.
As of Monday, Mosel Vitelic, Silicon Precisionware, and Highbridge Holdings accounted for 51.5% of the shares outstanding. This seems to have been a drag on possible movements to the upside. In an interesting move, Mosel Vitelic lowered its position in IMOS by nearly 10% on Monday.
Mosel Vitelic, Inc. Sells Stake in IMOS
The interesting part of this story is that Mosel liquidated 10% of its position for $6.30 per share, for a total loss of $47.9M New Taiwanese Dollars. The sale should not have a dilutive effect, since ProMOS Technology, Inc. and Powertech Technology, Inc. each purchased Mosel's 10% position.
Special Circumstances:
Investors should pay special attention to page 25 of the annual 20-F report for IMOS. The annual report gives a comprehensive discussion of the trends in semiconductor manufacturing, which we will attempt to summarize / paraphrase now.
IMOS discusses the current trends in the semiconductor manufacturing industry and argues that these trends are responsible for company growth. Simply, the majority of semiconductor manufacturers have started to outsource the production, back-end services, of semiconductors. As semiconductor companies become “fabless” companies like IMOS receive more business.
They identify three key trends for this shift to outsourcing:
1.) Significant Capital Expenditure Requirement: complex structures and shorter product life spans makes it more economically efficient for semiconductor companies to outsource the fabrication and testing of semiconductors. Outsourcing allows the major companies to share the risks of a possible downturn in the industry
2.) Increasing Focus on Core Competencies: simply, the increasing expenses associated with fabrication makes forces companies to focus on design, while outsourcing fabrication.
3.) Time-to-Market Pressure: shorter product life spans force companies to outsource production
IMOS also provides an answer why these trends are pertinent to the company:
Outsourcing in Taiwan and China:
Taiwan is a leading global market for outsourcing of semiconductor fabrication and testing. Most companies focus on a specific part of the fabrication and testing process, resulting in economies of scale, higher utilization rates, and greater flexibility. Lastly, the proximity of China and Taiwan allows for greater economies of scale and quicker production times, since all companies are based in the same general geographic location.
I hold a 400 share position in ChipMOS Tech Bermuda, and in order to quell any conflict of interest concerns, here are a few articles that support our research:
Smart Money on IMOS
Motley Fool's Take on IMOS
Forbes on IMOS
Regardless of my views on ChipMOS Tech Bermuda, many media outlets seem to believe that the company is undervalued.
Disclaimer: The author cannot be held responsible for any monies gained or lost from trades undertaken based on information presented herein. The author currently owns the following stocks: 400 shares of IMOS at $6.90.; Agilent Technologies, Inc. (A); Brasil Telecom S.A. (BRP); ConocoPhillips (COP), Biotel, Inc. (BTEL).
Sunday, July 22, 2007
The Height of Private Equity: Topps, Inc. - Part II
By: Steve Rubis
Recently, I provided an analysis of investing in Topps, Inc. (TOPP). The article made many salient points, but the argument was not articulate enough. This article will revisit the TOPP issue and provide the evidence that TOPP is a lackluster investment opportunity. First, I will address the response to my first article and then continue to a discussion of valuation which shows TOPP to be an inferior investment.
Response to Statements Stemming from My First Article:
My first article attempted to provide salient points as to why Topps, Inc. seems to be an inferior investment. The crux of my argument was that competition in the sports card industry led to hyper-inflation, which left two competitors in a stagnant industry. My statements elicited a response from Mr. Thomas Kircher:
Mr. Kircher's Discussion of Topps, Inc.
The article by Mr. Kircher argues that the hyper-inflation is a direct result of a rent seeking monopolist: Major League Baseball. If the hyper-inflation I describe was the result of a rent seeking monopolist, then baseball card collectors would have experienced such inflation during the 1950s and 60s. The chart below illustrates our disagreement with the rent seeking monopolist thesis.
Table 1: Hyper-Inflation in Baseball Card Prices
The table as well as the following discussion of baseball card history at Wikipedia shows that prices did not rise due to a rent seeking monopolist.
Wikipedia: History of Baseball Cards, See Section 1980s to Present
If anything, MLB and MLBPA limited the number of licenses in order to stop the plethora of sets due to extensive competition. Investors need look no further than the innovation that Upper Deck introduced in 1997: cards with swatches of memorabilia. The result of the memorabilia cards was a fan frenzy and rising prices. These memorabilia cards made buying unopened packs more like a lottery than pursuit of a true hobby.
We will concede that Upper Deck’s offer for Topps, Inc. might not encounter anti-trust risk. Nevertheless, there is always risk when the smaller fish tries to swallow the whale (Upper Deck has revenue of $60M, whereas Topps, Inc.’s revenue is $326M). The problem is that we still believe that Topps, Inc. is an inferior investment.
Lastly, we believe that the “nostalgic baby boomers with inelastic demand curves are inelastic” is incorrect. I do not see how anyone can make an argument that demand curves for baseball cards are inelastic. One might make a reasonable argument for secondary sales of high quality vintage memorabilia and cards experiencing inelastic demand, but not unopened packs of current baseball cards. I believe that a simple pole of regular card dealers would support the fact that baby boomers are interested in vintage material rather than current product. If baby boomers were willing to pay anything for a card, then vintage baseball cards would not have declined in prices during the last decade.
Valuation:
My first article lacked a thorough discussion of the value of Topps. I will start with a discussion of profitability and the business, followed by a DCF analysis, then a comparison of DCF value for competitors, and end with relative analysis.
In theory, Topps has a great business since it enjoys both product differentiation by providing a better product, and perceived differentiation through a trusted brand. The problem is that financial metrics do not support the previously stated theory. Return on Assets and Equity are a paltry 4.8% and 5.5% on a trailing twelve month basis according to Yahoo! Finance. Secondly, I calculate the WACC for Topps to be 13.95%, but the Return on Invested Capital (ROIC) is only 6.0%. This discrepancy between WACC and ROIC tells investors that Topps is efficiently eroding shareholder value.
Table 2: Discounted Cash Flow Analysis for Topps, Inc.
The discounted cash flow analysis of Topps presented above reinforces the fact that TOPP is an inferior investment. First, TOPP has a DCF value of $2.66 per share, well below the current price and below the two offers on the table. I decided to be generous and use a 10% growth rate for operating cash flow from 2008 to 2014. I also used a rolling three year average for CAPEX expenses in order to keep them flat. My rosy assumptions certainly did not help to increase the DCF value per share.
Table 3: Comparison of DCF Values for Confectioners
Since the main business of Topps, Inc. is bubble gum, the confectioner industry seems most appropriate for comparison. Table three shows different discounted cash flow values for selected companies in the confectioner industry. A purchase of Topps at current levels suggests that an investor has a rosy outlook for the baseball card industry. The comparison suggests that investors are better suited to consider some of Topps competitors in the confectioner space.
Table 4: Relative Analysis Metrics for Confectioners Industry
Topps once again disappoints on a relative analysis basis, since it is overvalued on a price to earnings, price to EBITDA, and enterprise value to EBITDA. The company is undervalued on a price to sales and price to book value basis.
Current investors in Topps should expect two outcomes: (1) a 6% rise to the upside, which is the price of Upper Deck’s offer; or, (2) a 10% decline to the price of Mr. Eisner’s offer. Holding Topps at current levels represents a significant opportunity cost. There are many other equities, some within the confectioner industry, which offer greater investment returns. If you think Topps is a superior investment, I have some Ron Kittle rookie cards I would like to sell you; I hear they could be a good investment!
*The author owns the following: A, BRP, BTEL.OB, COP, IMOS, VRGY. The author cannot be held liable for monies gained or lost due to trades undertaken based on information presented herein. Financial Data take from Yahoo! Finance and Google Finance.
Recently, I provided an analysis of investing in Topps, Inc. (TOPP). The article made many salient points, but the argument was not articulate enough. This article will revisit the TOPP issue and provide the evidence that TOPP is a lackluster investment opportunity. First, I will address the response to my first article and then continue to a discussion of valuation which shows TOPP to be an inferior investment.
Response to Statements Stemming from My First Article:
My first article attempted to provide salient points as to why Topps, Inc. seems to be an inferior investment. The crux of my argument was that competition in the sports card industry led to hyper-inflation, which left two competitors in a stagnant industry. My statements elicited a response from Mr. Thomas Kircher:
Mr. Kircher's Discussion of Topps, Inc.
The article by Mr. Kircher argues that the hyper-inflation is a direct result of a rent seeking monopolist: Major League Baseball. If the hyper-inflation I describe was the result of a rent seeking monopolist, then baseball card collectors would have experienced such inflation during the 1950s and 60s. The chart below illustrates our disagreement with the rent seeking monopolist thesis.
Table 1: Hyper-Inflation in Baseball Card Prices
The table as well as the following discussion of baseball card history at Wikipedia shows that prices did not rise due to a rent seeking monopolist.
Wikipedia: History of Baseball Cards, See Section 1980s to Present
If anything, MLB and MLBPA limited the number of licenses in order to stop the plethora of sets due to extensive competition. Investors need look no further than the innovation that Upper Deck introduced in 1997: cards with swatches of memorabilia. The result of the memorabilia cards was a fan frenzy and rising prices. These memorabilia cards made buying unopened packs more like a lottery than pursuit of a true hobby.
We will concede that Upper Deck’s offer for Topps, Inc. might not encounter anti-trust risk. Nevertheless, there is always risk when the smaller fish tries to swallow the whale (Upper Deck has revenue of $60M, whereas Topps, Inc.’s revenue is $326M). The problem is that we still believe that Topps, Inc. is an inferior investment.
Lastly, we believe that the “nostalgic baby boomers with inelastic demand curves are inelastic” is incorrect. I do not see how anyone can make an argument that demand curves for baseball cards are inelastic. One might make a reasonable argument for secondary sales of high quality vintage memorabilia and cards experiencing inelastic demand, but not unopened packs of current baseball cards. I believe that a simple pole of regular card dealers would support the fact that baby boomers are interested in vintage material rather than current product. If baby boomers were willing to pay anything for a card, then vintage baseball cards would not have declined in prices during the last decade.
Valuation:
My first article lacked a thorough discussion of the value of Topps. I will start with a discussion of profitability and the business, followed by a DCF analysis, then a comparison of DCF value for competitors, and end with relative analysis.
In theory, Topps has a great business since it enjoys both product differentiation by providing a better product, and perceived differentiation through a trusted brand. The problem is that financial metrics do not support the previously stated theory. Return on Assets and Equity are a paltry 4.8% and 5.5% on a trailing twelve month basis according to Yahoo! Finance. Secondly, I calculate the WACC for Topps to be 13.95%, but the Return on Invested Capital (ROIC) is only 6.0%. This discrepancy between WACC and ROIC tells investors that Topps is efficiently eroding shareholder value.
Table 2: Discounted Cash Flow Analysis for Topps, Inc.
The discounted cash flow analysis of Topps presented above reinforces the fact that TOPP is an inferior investment. First, TOPP has a DCF value of $2.66 per share, well below the current price and below the two offers on the table. I decided to be generous and use a 10% growth rate for operating cash flow from 2008 to 2014. I also used a rolling three year average for CAPEX expenses in order to keep them flat. My rosy assumptions certainly did not help to increase the DCF value per share.
Table 3: Comparison of DCF Values for Confectioners
Since the main business of Topps, Inc. is bubble gum, the confectioner industry seems most appropriate for comparison. Table three shows different discounted cash flow values for selected companies in the confectioner industry. A purchase of Topps at current levels suggests that an investor has a rosy outlook for the baseball card industry. The comparison suggests that investors are better suited to consider some of Topps competitors in the confectioner space.
Table 4: Relative Analysis Metrics for Confectioners Industry
Topps once again disappoints on a relative analysis basis, since it is overvalued on a price to earnings, price to EBITDA, and enterprise value to EBITDA. The company is undervalued on a price to sales and price to book value basis.
Current investors in Topps should expect two outcomes: (1) a 6% rise to the upside, which is the price of Upper Deck’s offer; or, (2) a 10% decline to the price of Mr. Eisner’s offer. Holding Topps at current levels represents a significant opportunity cost. There are many other equities, some within the confectioner industry, which offer greater investment returns. If you think Topps is a superior investment, I have some Ron Kittle rookie cards I would like to sell you; I hear they could be a good investment!
*The author owns the following: A, BRP, BTEL.OB, COP, IMOS, VRGY. The author cannot be held liable for monies gained or lost due to trades undertaken based on information presented herein. Financial Data take from Yahoo! Finance and Google Finance.
Question About Verigy, Ltd.
Q: Recently, a reader named Javier asked why do I own the undervalued IMOS and most over valued VRGY?
A: The reason is that I received my Verigy shares as a special dividend from Agilent Technologies. Agilent spun off Verigy in a special dividend last November. An argument can obviously be made that I should sell my shares. The reason I have not sold is that the shares have doubled in price, and if I can stretch my holding period to greater than one year, I can lower my tax base.
A: The reason is that I received my Verigy shares as a special dividend from Agilent Technologies. Agilent spun off Verigy in a special dividend last November. An argument can obviously be made that I should sell my shares. The reason I have not sold is that the shares have doubled in price, and if I can stretch my holding period to greater than one year, I can lower my tax base.
Wednesday, July 18, 2007
Comparative Valuation of Selected Semiconductor Equipment and Material Stocks
By: Steve Rubis
ChipMOS Tech Bermuda (IMOS) Looks Attractive
Recommendation:
We reiterate our interest in ChipMOS Tech Bermuda as an undervalued opportunity. The company sports a depression level price due to a low Altman Z Score and a convoluted management / ownership structure. These issues are reflected in IMOS’s current price which is slightly above book value.
Valuation Comparison:
Table 1: Equity Valuations for the Top Values in the Semiconductor Equipment and Material Industry
The four companies in our comparison appeared undervalued in our initial valuation analysis. Our comparison suggests that ChipMOS Tech Bermuda offers investors quite a deal. Private equity values are in the $30’s and a relative multiple analysis pegs fair value in the mid-teens to low twenties. Furthermore, ChipMOS Tech Bermuda gives an adequate showing in terms of earning power and reproduction value. The key metric to watch in terms of the IMOS story are profit margins. If IMOS can partake in the estimated industry growth, then the company should trade for at both a higher P/E and P/S ratio. The other three stocks leave something to be desired since they offer little to no margin of safety.
Stock Universe:
Table 2: Undervalued universe for the Semiconductor Equipment and Material Industry
The industry balances in terms of undervalued and overvalued securities. Eight stocks are overvalued while 10 are possibly undervalued. Investors will notice a difference between the percent discounts of Table 1 and Table 2. Differences are results of the use of averages and differences in valuation data used between the two charts. The bulk of the valuation difference is attributable to the earnings power and reproduction values shown on Table 1.
Valuation Calculations:
Table 3: Take Out Valuations for Selected Semiconductor Equipment and Material Stocks
The majority of the selected companies perform well on the private equity value test. The discounts are quite steep for three of the companies ranging from 35% to 79%.
Table 4: Relative Valuation of Selected Semiconductor Equipment and Material Stocks
The same three companies perform strongly on the relative value test as well. Again, the values are quite compelling for ChipMOS Tech Bermuda. Each metric suggests that investors believe that ChipMOS Tech Bermuda will encounter financial difficulty. We will address these concerns in our future write up of ChipMOS Tech Bermuda.
Table 5: Earnings Power and Reproduction Values of Selected Semiconductor Equipment and Material Stocks
ChipsMOS Tech Bermuda provides the strongest showing in a comparison of earnings power and reproduction values. The other companies involved in the comparative analysis all fail this examination. ChipMOS’s showing has interesting implications; the company’s earnings seem to be worth $15 per share and reproducing the business from scratch about $11 per share. These suggested prices make ChipMOS quite attractive because both values are well above the current price. Investors can make a strong case for ChipMOS moving closer to the $11 to $15 range.
The above valuation analysis suggests that investors might be unfairly punishing ChipMOS Tech Bermuda. Investor sentiment led us to taking a position in ChipMOS, and we think the company is worthy of further research.
Disclaimers:
*The author owns 400 shares of IMOS at an average price of $6.90.
**The author cannot be held responsible for any money gained or loss from trades undertaken based on information presented herein.
***The author currently owns: A, BRP, BTEL.OB, COP, IMOS, and VRGY
****Financial data comes from Yahoo!Finance
ChipMOS Tech Bermuda (IMOS) Looks Attractive
Recommendation:
We reiterate our interest in ChipMOS Tech Bermuda as an undervalued opportunity. The company sports a depression level price due to a low Altman Z Score and a convoluted management / ownership structure. These issues are reflected in IMOS’s current price which is slightly above book value.
Valuation Comparison:
Table 1: Equity Valuations for the Top Values in the Semiconductor Equipment and Material Industry
The four companies in our comparison appeared undervalued in our initial valuation analysis. Our comparison suggests that ChipMOS Tech Bermuda offers investors quite a deal. Private equity values are in the $30’s and a relative multiple analysis pegs fair value in the mid-teens to low twenties. Furthermore, ChipMOS Tech Bermuda gives an adequate showing in terms of earning power and reproduction value. The key metric to watch in terms of the IMOS story are profit margins. If IMOS can partake in the estimated industry growth, then the company should trade for at both a higher P/E and P/S ratio. The other three stocks leave something to be desired since they offer little to no margin of safety.
Stock Universe:
Table 2: Undervalued universe for the Semiconductor Equipment and Material Industry
The industry balances in terms of undervalued and overvalued securities. Eight stocks are overvalued while 10 are possibly undervalued. Investors will notice a difference between the percent discounts of Table 1 and Table 2. Differences are results of the use of averages and differences in valuation data used between the two charts. The bulk of the valuation difference is attributable to the earnings power and reproduction values shown on Table 1.
Valuation Calculations:
Table 3: Take Out Valuations for Selected Semiconductor Equipment and Material Stocks
The majority of the selected companies perform well on the private equity value test. The discounts are quite steep for three of the companies ranging from 35% to 79%.
Table 4: Relative Valuation of Selected Semiconductor Equipment and Material Stocks
The same three companies perform strongly on the relative value test as well. Again, the values are quite compelling for ChipMOS Tech Bermuda. Each metric suggests that investors believe that ChipMOS Tech Bermuda will encounter financial difficulty. We will address these concerns in our future write up of ChipMOS Tech Bermuda.
Table 5: Earnings Power and Reproduction Values of Selected Semiconductor Equipment and Material Stocks
ChipsMOS Tech Bermuda provides the strongest showing in a comparison of earnings power and reproduction values. The other companies involved in the comparative analysis all fail this examination. ChipMOS’s showing has interesting implications; the company’s earnings seem to be worth $15 per share and reproducing the business from scratch about $11 per share. These suggested prices make ChipMOS quite attractive because both values are well above the current price. Investors can make a strong case for ChipMOS moving closer to the $11 to $15 range.
The above valuation analysis suggests that investors might be unfairly punishing ChipMOS Tech Bermuda. Investor sentiment led us to taking a position in ChipMOS, and we think the company is worthy of further research.
Disclaimers:
*The author owns 400 shares of IMOS at an average price of $6.90.
**The author cannot be held responsible for any money gained or loss from trades undertaken based on information presented herein.
***The author currently owns: A, BRP, BTEL.OB, COP, IMOS, and VRGY
****Financial data comes from Yahoo!Finance
Tuesday, July 17, 2007
Semiconductor Equipment and Material - Growth in Taiwan and China
By: Steve Rubis
Recommendation:
Our interest in this space is due to the multiple articles on ChipMOS Tech Bermuda (IMOS) and its inexpensive valuation. Analysis suggests that IMOS is undervalued, but the rest of this space seems fairly valued. Semi.org, the semiconductor trade organization, sees 1% growth in revenue for equipment and 10% for materials in 2007 and 2008. Furthermore, it identifies China and Taiwan as the hottest growth areas for this industry; IMOS operates in Taiwan. The industry is ranked 76 out of 197 companies according to the July 16, 2007, Investors Business Daily.
Investment Thesis:
ChipMOS Tech Bermuda (IMOS) trades at depression levels. The company is significantly undervalued on a P/E, P/S, and P/B basis. Semi.org’s outlook on the industry makes us think, despite a low Altman Z Score, that IMOS is truly a bargain.
Industry Metrics:
Table 1: Key Financial Metrics for the Semiconductor Equipment and Materials
The Semiconductor Equipment and Material industry is somewhat mature given that 22 out of 25 companies are mid or large cap companies. Relative metrics for the industry are reasonable; the 22.5 P/E seems quite reasonable for a technology industry such as this. The high cost of capital is expected given the risks due to the cyclical nature of the industry. Finally, management seems to be average given the modest returns on assets and equity.
Valuation:
Table 2: Average Per Share Values for the Semiconductor Equipment and Material
Investors can see from the metrics above that the industry is fairly priced. The gap between earnings power value and reproduction value should be alarming to investors. Such a gap suggests that the reproduction value is overstated, since the earnings power should be worth more than the assets.
Financial Health
Table 3: Altman Z Score for Selected Semiconductor Equipment and Material Stocks
The Altman Z Score for these four companies result in a view opposite to our thesis. These scores suggest that IMOS is undervalued because some might believe it will experience financial distress. This presents a dichotomy because industry estimates suggest growth, but the financials suggest trouble. The distressed valuation that IMOS sports suggests that any possible financial troubles are reflected in the current price.
Business Prospects:
Full Article From Semi.org on Semiconductor Materials Outlook
Full Article From Semi.org on Semiconductor Equipment Outlook
Eric Savitz Reports on Semiconductor Equipment Stocks
Best Values:
1.) ChipMOS Tech Bermuda (IMOS): roughly 75% undervalued, the stock is attractive on all valuation metrics
*The author owns 400 shares of IMOS at a price of $6.90.
**The author currently owns: A, BRP, BTEL.OB, COP, IMOS, and VRGY.
***The author cannot be held responsible for monies gained or lost due to trades undertaken based on information presented herein.
****Financial data comes from Yahoo!Finance.
Recommendation:
Our interest in this space is due to the multiple articles on ChipMOS Tech Bermuda (IMOS) and its inexpensive valuation. Analysis suggests that IMOS is undervalued, but the rest of this space seems fairly valued. Semi.org, the semiconductor trade organization, sees 1% growth in revenue for equipment and 10% for materials in 2007 and 2008. Furthermore, it identifies China and Taiwan as the hottest growth areas for this industry; IMOS operates in Taiwan. The industry is ranked 76 out of 197 companies according to the July 16, 2007, Investors Business Daily.
Investment Thesis:
ChipMOS Tech Bermuda (IMOS) trades at depression levels. The company is significantly undervalued on a P/E, P/S, and P/B basis. Semi.org’s outlook on the industry makes us think, despite a low Altman Z Score, that IMOS is truly a bargain.
Industry Metrics:
Table 1: Key Financial Metrics for the Semiconductor Equipment and Materials
The Semiconductor Equipment and Material industry is somewhat mature given that 22 out of 25 companies are mid or large cap companies. Relative metrics for the industry are reasonable; the 22.5 P/E seems quite reasonable for a technology industry such as this. The high cost of capital is expected given the risks due to the cyclical nature of the industry. Finally, management seems to be average given the modest returns on assets and equity.
Valuation:
Table 2: Average Per Share Values for the Semiconductor Equipment and Material
Investors can see from the metrics above that the industry is fairly priced. The gap between earnings power value and reproduction value should be alarming to investors. Such a gap suggests that the reproduction value is overstated, since the earnings power should be worth more than the assets.
Financial Health
Table 3: Altman Z Score for Selected Semiconductor Equipment and Material Stocks
The Altman Z Score for these four companies result in a view opposite to our thesis. These scores suggest that IMOS is undervalued because some might believe it will experience financial distress. This presents a dichotomy because industry estimates suggest growth, but the financials suggest trouble. The distressed valuation that IMOS sports suggests that any possible financial troubles are reflected in the current price.
Business Prospects:
Full Article From Semi.org on Semiconductor Materials Outlook
Full Article From Semi.org on Semiconductor Equipment Outlook
Eric Savitz Reports on Semiconductor Equipment Stocks
Best Values:
1.) ChipMOS Tech Bermuda (IMOS): roughly 75% undervalued, the stock is attractive on all valuation metrics
*The author owns 400 shares of IMOS at a price of $6.90.
**The author currently owns: A, BRP, BTEL.OB, COP, IMOS, and VRGY.
***The author cannot be held responsible for monies gained or lost due to trades undertaken based on information presented herein.
****Financial data comes from Yahoo!Finance.
Wednesday, July 11, 2007
Topps, Inc.: Private Equity At Its Apex
By: Steve Rubis
In March 2007, Michael Eisner, with the help of Madison Dearborn Partners, made a $9.75 per share all cash offer for Topps, Inc. Recently, the Upper Deck, LLC the sole rival to Topps in the trading card business submitted a $10.75 all cash offer. In our eyes, the Topps buyout discussion is signaling a top (no pun intended) in the Private Equity industry. Any investor who understands the landscape of the trading card market of the past 15 years knows that such a buyout makes no sense. In essence, the deal makes perfect sense for Upper Deck, but not for Private Equity. Any Private Equity firm interested in Topps has money burning a whole in the company’s pocket.
First, why would anyone want to buy a company like Topps, Inc.? The company has nearly $81M in cash, or about $2.10 per share and a $5.24 book value. These facts make Topps an attractive buyout candidate because there is no debt on the balance sheet. In essence owners of Topps shares are getting $2.10 in cash, $3.14 in tangible assets, and finally paying $5.18 per share for the business. On the look of it, a price range of $9.75 to $10.75 per share looks cheap. The problem is that anyone with an understanding of the trading card business should be baffled by Eisners offer, quizzical of Upper Deck’s offer, and understanding of Topps anti-trust concerns.
To understand our discontent with the coverage and analysis of this situation, investors must start with a simple history of the trading card market over the last 26 years. In 1981, Topps lost its monopoly on baseball cards when Donruss and Fleer were allowed to licenses for baseball cards. These companies were the big three until the late 80s when Score, Sportflics, and Upper Deck came alive. Upper Deck’s product would revolutionize the industry, which helped send trading cards on a downward spiral beginning in 1991. With the advent of premium brands such as Studio, Leaf and Topps Stadium Club, trading card producers started to price themselves out of the market. Children paying $0.50 for a pack of 15 cards and stick of gum were no longer the target market. Rather, the companies sought to reach more adults with prices of nearly $3.00 for a pack of 15 cards and no gum.
This premium mania caused numerous bankruptcies, mass consolidation, and inflated prices. During the 1990’s, companies like SkyBox, Hoops, Score’s multiple sub-brands, Pacific, Playoff, Classic, Collector’s Edge, GameDay, and even Ted Williams attempted to obtain market share. The result was extreme market saturation with each company producing nearly 10 different brands a year on average by 1999. Beckett Publications, the main price guide for trading cards, had to substantially condense their pricing coverage in order to provide pertinent pricing data. By the early 2000’s, the market was so saturated that Beckett had to begin producing a monthly guide and a quarterly guide in order to provide adequate pricing for all of the product on the market.
Ultimately, the mass market saturation resulted in numerous bankruptcies. Many of the smaller brands listed above would be gone before 2002, e.g.: Ted Williams, GameDay, Hoops, SkyBox became part of Fleer. Playoff would be bought, along with Score and Donruss. Pacific would become extinct due to a lack of licenses from the MLBPA and NFLPA needed in order to produce cards. The consolidation would leave Fleer, Topps and Upper Deck as the big three. As these companies competed, the target market became even more luxurious, as the companies began to offer packs of cards at $100 for 4 cards. This attraction to the high luxury market led to the fiscal insolvency of Fleer, which apparently is now part of Upper Deck.
History now brings us to the current paradox: why would Mr. Eisner want to buy Topps? Secondly, does Upper Deck really think the FTC would allow them to buy Topps? Lastly, why do analysts think Topps is wrong to suggest anti-trust problems regarding Upper Deck’s offer?
Mr. Eisner and Madison Dearborn Partners are interested for the cash position and the ability to purchase a cheap business. The beauty of the transaction is that Mr. Eisner would be getting a premium brand for a discount of about $81M. This means that rather than paying $377.9M for the company, he really pays $296.3M. The cash position acts as a discount since no debt exists. Mr. Eisner and Madison Dearborn like this position because Topps has $326.7M in revenue and they would be paying only $296.3M for this revenue stream. At first glance not a bad deal, especially if these private equity investors are able to turn the business around. The problem is that we do not believe the problems that face Topps, Inc. can be turned around by intelligent financiers given the climate of the industry as a whole.
The major problem facing the trading card industry is that per pack prices have seen Weimar Germany like inflation over the last 15 years. In 1990, a collector could purchase a pack of 15 premium cards for about $2.00. Today that same pack averages $3.00 for 3 or 4 premium cards. The price per card in 1990 was about $0.13 and today that same card costs collectors $1.00. This results in about 669% inflation for the 15 year period.
Secondly, why does Upper Deck think they will be able to purchase Topps? Upper Deck is probably interested for the same financial reasons as Mr. Eisner, however. Upper Deck has more enticements to complete the transaction. The company’s product is superior to Topps, adding the Topps brand to Upper Deck would give it a monopoly and prestige among collectors that has not existed since 1981; in essence there would be a trading card monopoly with Upper Deck being the winner.
The problem is that Upper Deck made an inferior offer if they want to be taken seriously. To understand why, investors need to analyze the goodwill that the Topps brand would bring to Upper Deck. Trading card collectors would probably agree that the value of the Topps brand is worth more than the $1 premium over Mr. Eisner’s offer. As stated earlier, if the Upper Deck purchase were to be completed, a monopoly in trading cards would exist. This is highly unlikely, since the FTC would most likely halt the transaction. That being said, it would seem justified that Upper Deck would offer a higher bid if it truly wanted to secure the Topps brand. The $10.75 per share price is truly inferior to the $9.75 price due to the unlikelihood of completion.
Lastly, Topps is warranted in its concerns that the Upper Deck bid would not be consummated due to FTC concerns. If Upper Deck bought Topps a monopoly would exist, and the FTC exists so such scenarios do not unfold. This reason alone makes Mr. Eisner’s bid superior even though his offer is $1.00 less than Upper Deck. We believe that Upper Deck does not adequately compensate investors for the amount of risk that exists regarding its offer for Topps.
Here are some articles so that our readers may see what other people are saying about Topps:
Clyde Milton's Take On Mr. Eisner's Offer for Topps
Gannon On the Topps Take Out Offer
Rick Munarriz's, The Motley Fool, Take On the Bidding War
We do not recommend investors purchase shares in Topps, Inc. Investors would be better off going to www.ebay.com, and purchasing as many 1986 Topps Traded sets as possible for whatever amount one would invest directly in Topps, Inc. Investors are better compensated for the risk inherent in the latter investment.
*The author does not own any shares in Topps, Inc. and will never purchase any
**The author cannot be held responsible for gains or loss achieved based on trades undertaken because of information presented herein.
***The author owns long positions in: Agilent Technologies (A), Brasil Telecom Participcoes S.A. (BRP), ConocoPhillips (COP), ChipMOS Tech Bermuda (IMOS), and Verigy, Ltd. (VRGY)
In March 2007, Michael Eisner, with the help of Madison Dearborn Partners, made a $9.75 per share all cash offer for Topps, Inc. Recently, the Upper Deck, LLC the sole rival to Topps in the trading card business submitted a $10.75 all cash offer. In our eyes, the Topps buyout discussion is signaling a top (no pun intended) in the Private Equity industry. Any investor who understands the landscape of the trading card market of the past 15 years knows that such a buyout makes no sense. In essence, the deal makes perfect sense for Upper Deck, but not for Private Equity. Any Private Equity firm interested in Topps has money burning a whole in the company’s pocket.
First, why would anyone want to buy a company like Topps, Inc.? The company has nearly $81M in cash, or about $2.10 per share and a $5.24 book value. These facts make Topps an attractive buyout candidate because there is no debt on the balance sheet. In essence owners of Topps shares are getting $2.10 in cash, $3.14 in tangible assets, and finally paying $5.18 per share for the business. On the look of it, a price range of $9.75 to $10.75 per share looks cheap. The problem is that anyone with an understanding of the trading card business should be baffled by Eisners offer, quizzical of Upper Deck’s offer, and understanding of Topps anti-trust concerns.
To understand our discontent with the coverage and analysis of this situation, investors must start with a simple history of the trading card market over the last 26 years. In 1981, Topps lost its monopoly on baseball cards when Donruss and Fleer were allowed to licenses for baseball cards. These companies were the big three until the late 80s when Score, Sportflics, and Upper Deck came alive. Upper Deck’s product would revolutionize the industry, which helped send trading cards on a downward spiral beginning in 1991. With the advent of premium brands such as Studio, Leaf and Topps Stadium Club, trading card producers started to price themselves out of the market. Children paying $0.50 for a pack of 15 cards and stick of gum were no longer the target market. Rather, the companies sought to reach more adults with prices of nearly $3.00 for a pack of 15 cards and no gum.
This premium mania caused numerous bankruptcies, mass consolidation, and inflated prices. During the 1990’s, companies like SkyBox, Hoops, Score’s multiple sub-brands, Pacific, Playoff, Classic, Collector’s Edge, GameDay, and even Ted Williams attempted to obtain market share. The result was extreme market saturation with each company producing nearly 10 different brands a year on average by 1999. Beckett Publications, the main price guide for trading cards, had to substantially condense their pricing coverage in order to provide pertinent pricing data. By the early 2000’s, the market was so saturated that Beckett had to begin producing a monthly guide and a quarterly guide in order to provide adequate pricing for all of the product on the market.
Ultimately, the mass market saturation resulted in numerous bankruptcies. Many of the smaller brands listed above would be gone before 2002, e.g.: Ted Williams, GameDay, Hoops, SkyBox became part of Fleer. Playoff would be bought, along with Score and Donruss. Pacific would become extinct due to a lack of licenses from the MLBPA and NFLPA needed in order to produce cards. The consolidation would leave Fleer, Topps and Upper Deck as the big three. As these companies competed, the target market became even more luxurious, as the companies began to offer packs of cards at $100 for 4 cards. This attraction to the high luxury market led to the fiscal insolvency of Fleer, which apparently is now part of Upper Deck.
History now brings us to the current paradox: why would Mr. Eisner want to buy Topps? Secondly, does Upper Deck really think the FTC would allow them to buy Topps? Lastly, why do analysts think Topps is wrong to suggest anti-trust problems regarding Upper Deck’s offer?
Mr. Eisner and Madison Dearborn Partners are interested for the cash position and the ability to purchase a cheap business. The beauty of the transaction is that Mr. Eisner would be getting a premium brand for a discount of about $81M. This means that rather than paying $377.9M for the company, he really pays $296.3M. The cash position acts as a discount since no debt exists. Mr. Eisner and Madison Dearborn like this position because Topps has $326.7M in revenue and they would be paying only $296.3M for this revenue stream. At first glance not a bad deal, especially if these private equity investors are able to turn the business around. The problem is that we do not believe the problems that face Topps, Inc. can be turned around by intelligent financiers given the climate of the industry as a whole.
The major problem facing the trading card industry is that per pack prices have seen Weimar Germany like inflation over the last 15 years. In 1990, a collector could purchase a pack of 15 premium cards for about $2.00. Today that same pack averages $3.00 for 3 or 4 premium cards. The price per card in 1990 was about $0.13 and today that same card costs collectors $1.00. This results in about 669% inflation for the 15 year period.
Secondly, why does Upper Deck think they will be able to purchase Topps? Upper Deck is probably interested for the same financial reasons as Mr. Eisner, however. Upper Deck has more enticements to complete the transaction. The company’s product is superior to Topps, adding the Topps brand to Upper Deck would give it a monopoly and prestige among collectors that has not existed since 1981; in essence there would be a trading card monopoly with Upper Deck being the winner.
The problem is that Upper Deck made an inferior offer if they want to be taken seriously. To understand why, investors need to analyze the goodwill that the Topps brand would bring to Upper Deck. Trading card collectors would probably agree that the value of the Topps brand is worth more than the $1 premium over Mr. Eisner’s offer. As stated earlier, if the Upper Deck purchase were to be completed, a monopoly in trading cards would exist. This is highly unlikely, since the FTC would most likely halt the transaction. That being said, it would seem justified that Upper Deck would offer a higher bid if it truly wanted to secure the Topps brand. The $10.75 per share price is truly inferior to the $9.75 price due to the unlikelihood of completion.
Lastly, Topps is warranted in its concerns that the Upper Deck bid would not be consummated due to FTC concerns. If Upper Deck bought Topps a monopoly would exist, and the FTC exists so such scenarios do not unfold. This reason alone makes Mr. Eisner’s bid superior even though his offer is $1.00 less than Upper Deck. We believe that Upper Deck does not adequately compensate investors for the amount of risk that exists regarding its offer for Topps.
Here are some articles so that our readers may see what other people are saying about Topps:
Clyde Milton's Take On Mr. Eisner's Offer for Topps
Gannon On the Topps Take Out Offer
Rick Munarriz's, The Motley Fool, Take On the Bidding War
We do not recommend investors purchase shares in Topps, Inc. Investors would be better off going to www.ebay.com, and purchasing as many 1986 Topps Traded sets as possible for whatever amount one would invest directly in Topps, Inc. Investors are better compensated for the risk inherent in the latter investment.
*The author does not own any shares in Topps, Inc. and will never purchase any
**The author cannot be held responsible for gains or loss achieved based on trades undertaken because of information presented herein.
***The author owns long positions in: Agilent Technologies (A), Brasil Telecom Participcoes S.A. (BRP), ConocoPhillips (COP), ChipMOS Tech Bermuda (IMOS), and Verigy, Ltd. (VRGY)
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