"The World is Over-Leveraged" (ACG Recap on Buying Distressed Assets)

Jeff Werbalowsky, co-CEO of Houlihan Lokey, stated in November 2007 that the "world is over-leveraged." (See video of the interview here.) Based on his comments from Tuesday's ACG Luncheon, I doubt he thinks much has changed in the 18 months since then.

Alongside Jeff was Daryle Uphoff (Mg Partner of Lindquist & Vennum) and Steve Rosen (co-founder of turnaround firm Resilience Capital). Houlihan's Jeff Arnesen acted as emcee.

Here are some highlights:

• Risk is currently overpriced. Rosen mentioned that had been underpriced in the past, but now believes that risk is being overpriced. The pendulum has swung too far toward fear, and away from risk, he said.


• Comment from Drew: Does this mean that it's a buyers' market? Rosen continued to be pessimistic about buying opportunities, which seemed to conflict with his "risk is overpriced" question. I wish I had the opportunity to ask him whether he's overall bullish or bearish on asset valuations.



• Goodbye, Refi. Gone are the halcyon days of easy hedge fund refinancing and corporate debt default rates. At the end of 2006, corporate defaults occured <1%.>. Find that here.



• A Broad-based Economic Downturn. Daryle noted that past recessions were contained because they were industry- or geographic-specific (1981 S&L crisis, 1998 Asian Currency/Long-Term Capital Mgmt and 2001 .com). This recession, in contrast, has had a 'systematic' effect. As a result, it's infecting all aspects on the economy. The fact that there are fewer industries that are doing well means there isn't an impetus to jumpstart the economy and adds to the fear of an "L" or "U" shaped recovery rather the "V" to which we've become accustomed

• The Slow Motion Commercial Real-Estate Tsunami. Werbalowsky argued that commercial real estate is the next bubble to pop. No one disagreed. His reason -- and I find this compelling -- is that the financing of real estate is on a different time horizon than banks. Banks are financed on overnight or 30-day commercial paper. Thus, when things go bad, the liquidity hits them quickly as they fail to roll over their liabilities. The opposite is true with commercial real estate: their tenants sign long-term contracts that renew on a much slower timetable than banks -- 12, 24, or 36 months. "That's my future inventory" Werbalowsky said.
• Connecting this comment to Uphoff's (regarding systematic vs. contained recessions), I am trying to determine how broad-based commercial real estate is. Are its 'tentacles' so broad that a downturn there has domino results elsewhere? Or, alternatively, does a downturn in commercial real estate mean lower SG&A expenses for other businesses (lower lease costs) and thus better margins? Does one compound the other, or is one's pain the other's gain?
• Your thoughts are welcome: askniffin@stthomas.edu

I'm off to canoe the Buffalo River for the next week, so be patient if I don't report anything immediately regarding the upcoming TGT shareholder's mtg.

New CEO at Supervalu

Supervalu -- at $44B FY08 revenues Minnesota's 3rd largest company and the 51st largest in the country -- announced today that 62 year old Jeffrey Noddle will step down as CEO.

Craig Herkert, WMT's "president and CEO of the Americas" will take over. He is 49. Prior to WMT, Herkert was with Albertson's -- the company that SVU purchased 3 years ago in a massive acquisition whose synergies have largely never been realized. SVU stock was down on the news.

From the Strib: "Noddle was named CEO in 2001 and chairman of the board in 2002. He steered the company through its largest acquisition in 2006: the $17.4 billion purchase of Albertson's Inc. Supervalu paid $3.8 billion in cash and $2.5 billion in stock and took on $6.1 billion in Albertson's debt. Its partners in the deal included Rhode Island's CVS Corp., New York-based Cerberus Capital Management, Kimco Realty and Schottenstein Stores Corp. of Columbus, Ohio."

By coincidence, I have been modeling and studying SVU this semester. I value its stock at $37.29. This number is based on a 50/50 weighting of discounted cash flow and EV/EBITDA, using comp companies of Kroger, Safeway, and Wal-Mart. The DCF assumes zero revenue growth through 2013. (Sorry for the small screen shots -- I'll try to adjust)

1) Financial Ratio Analysis


2) DCF Analysis (note no revenue growth through 2013)

3) EV/EBITDA Analysis

		2009	SVU	KR	SWY	WMT	Industry Average
	Equity Value
		52 wk high	35.61	30.32	32.65	63.17
		52 wk low	9.02	19.46	17.23	46.42
		Shares O/S (m)	211.75	652.34	427.05	3910
			4,725	16,237	10,651	214,248
	(add) LT Debt Value		7,968	7,505	4,701	34,549
	(subrtract) Cash Value		240	263	383	7,275
	Enterprise Value		12,453	23,479	14,969	241,522
	EBITDA		-1,100	3,893	2,994	29,537
	EV/EBITDA		NM	6.0	5.0	8.2	6.4
	SVU Valuation based on Industry EV/EBITDA:
	1)	Normalize EBITDA as % of sales:
			EBIT	DA	EBITDA	Sales	%	Weighting
		2008	1,648	1,017	2,665	44,048	6.1%	60%	3.6%
		2007	1,305	879	2,184	37,406	5.8%	30%	1.8%
		2006	435	311	746	19,864	3.8%	10%	0.4%
									5.8%
	2)	Estimate FY 2010 Sales:
		43,239,600
	3)	Multiply #1 and #2 to obtain estimated FY 2010 EBITDA:
		2,489,423
	4)	Apply multiple to obtain estimated FY 2010 Enterprise Value:
		15,938,531
	5)	Add back estimated cash and subtract estimated debt to obtain Estimated 2010 Market Capitalization
		8,376,531
	6)	Divide by shares outstanding (diluted)
		$38.96

Pepsi Developments...

Pepsi Bottling Group rejected PepsiCo's squeeze-out buyout offer as "grossly inadequate". Their 8-K filing can be found here.

A Special Committee of Independent Directors was advised by Morgan Stanley and Cravath, Swaine, and Moore. The following reasons were given for the rejection:

1. Opportunistic Timing.
2. Inadequate Value.
3. Understated Synergies. **This was particularly interesting to me, given the 'modeling synergies' post I wrote in April. In theory, TargetCo should not receive any portion of the synergies value, since BuyCo brings that to the transaction. Nonetheless, PBG is making this one of its sticking points**

In addition, PBG announced the approval of a shareholder rights plan -- more commonly known as a "poison pill".

The interesting question is what effect this has on PepsiAmerica's evaluation of the offer it received. It is being advised by Briggs and Morgan's Brian Wegner, as well as Sullivan & Cromwell and Goldman Sachs.

PAS already has a poison pill plan, which was instituted in 1999 (It can be found in its latest 10-K at page F-36 and here).