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Minyan Mailbag: BBI

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The state of being public can make a company behave irrationally

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.


Jeff,


A quick comment on your questions about BBI's business model (and how it could go the way of the buggy whip makers). Let's say I was the last buggy whip maker, and could make the following earnings per share numbers into oblivion:

$1, $0.75, $0.50, $0.25 and 0.

What would you pay for this wasting asset?

I hope the answer is at least $1? (to eliminate any discussion of PV or DCF).

If so, then, if the stock is trading at $1, it cannot, under any circumstance, or over any time frame, be a good short.

If you look at BBI today, it is trading at essentially 1.38x its FREE CASH FLOW.

Now, I don't know everything about the company, but I wouldn't short anything with such a valuation.

Finally, they have a continuing competitive advantage over VOD: they get movies for a window of time before every other competing VOD cable or satellite business (something that the hollywood studios did to maximize their DVD rental revenues).

This final competitive advantage is "potentially" under assault, but until then, they are a viable business, in my honest opinion.

Positions: none. (was long last month)

Minyan AA



Minyan AA,

This is a great question as it illustrates an important point on the difference between analyzing public vs. private concerns. In short, the neccessity of public companies to "demonstrate growth" (real or hypothetical) causes the managers of those companies to behave in ways that would be non-starters for a private company with the same financial profile.

In the instance of Blockbuster (BBI) the issue with investing in the company from the long side on the above "wasting asset" thesis is that management has no stated or implied intent to operate with a mind towards maximizing cash flow. Indeed, I'm guessing that "wasting asset" are regarded as Fightin' Words by BBI in light of the company's outstanding bid for Hollywood Entertainment (HLYW).

So, we've got an existing store base that by Blockbuster's own admission needs considerable capital investment. We've got no real operational evidence that Blockbuster has their store models "fixed" (at least in the sense of being anything other than a wasting asset) and some $700 million earmarked for Hollywood's assets. Hollywood, as we know, is more of a retail operation which, again, BBI hasn't demonstrated an ability to run without a late-fee dependent model.

[Quick aside on late-fees and the new BBI ad-campaign announcing "No More Late Fees (at participating stores)". The new structure is that movies kept more than 7 days are charged at full retail to customers' credit cards. If/ when the customer returns the movie they have a late fee deducted from the amount returned to the customer. In other words, they still have late fees but have capped them at full-retail. I'm standing behind my notion that this plan doesn't end well.]

I don't disagree that Blockbuster seems reasonably cheap at these levels. That said, I see no reason to expect that the company has any intent to maximize cash flow at all, let alone return that cash to investors.

I consider the stock much along the lines of tonight's USC vs. Oklahoma game. I'd frankly sort of enjoy seeing USC lose, if only for the OJ connection. I further think the OJ connection dooms USC to a hideous karmic beat-down, at some point. Alas, that's not a particularly investable thesis and I have no intention of (travelling to Nevada where it's legal and) putting any skin on the game.

So, I'll just be sitting on my couch watching, waiting for and expecting USC to be crushed but not seeking to profit from the event. In the big picture and at these levels, that's sort of my stance on Blockbuster.

Another "Wait and Watch" Name

Another nice example of both a company whose implosion was predictable but not tradeable (at least I'm not making money on it) as well as the pressures on public companies to "generate growth... any growth" is blowing up today in the form of Krispy Kreme (KKD).

Krispy Kreme was a rather nice private company for 63 years. Great product, nice franchise model, decent growth. The business model amounted to "Sell the licences, send out the mix, collect the money".

Krispy Kreme's problems were created when they had to convince the Street that they were "The Next Starbucks (SBUX)" [stop looking, we already have a Starbucks]. The models were created, analysts were wooed and, for a time, shorts were crushed.

Alas, doughnuts are doughnuts and as it turns out they aren't a particularly fast-growth industry. With the stakes now much higher for missing what was once an internal plan but was now a public measuring stick, shortcuts seem to have been taken, fudging seems to have occurred.

All of which is what many of the shorts went to their graves arguing would happen. If you went through the financials it was as clear as these things get that KKD was a mess waiting to happen. The company had limited, at best, controls over its franchisees the performance of which determined the execution of their growth plans.

The rub, and the reason I wasn't involved, was simply when the company would blow. I had no edge on that timing so I stayed on the couch... that's plenty annoying today with the stock down 20% but all I have to do is look at the 5-year chart to realize that keeping this thing on my sheets while I waited would have been too painful to get to the finish line.

No positions in stocks mentioned.

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