Beware of the Retail Investor (Or maybe stonks really do only go up?) – A few musings from CVI

What a wild world we are living in. If you had $600 billion dollars would you rather take the red pill and buy all of Berkshire Hathaway (~$537B) with all its business and its investment holdings including $115B of Apple stock… and then throw in General Motors (~$63B) as a little side bet or would you rather take the blue pill and outright own Tesla (market cap ~$600B)?

We’re red pill takers here at CVI, but maybe… stonks really do only go up.

The hero of our times - (Unaffiliated, available at www.teeherivar.com )

Today here at CVI we just want to take a moment to acknowledge the strange times we are living in. There is  great chart in the Economist from back in September (full article here - https://www.economist.com/finance-and-economics/2020/09/12/beware-the-power-of-retail-investors ) showing the growth in the use of call options by retail investors. It’s a lot. “The total nominal value of calls traded on individual American stocks hit a record high in the last two weeks of August, averaging $335bn a day, according to Goldman Sachs—the first time the average daily volume of traded stock options has exceeded trading volume for the shares themselves. The volume of calls was more than triple the rolling average between 2017 and 2019.”

“Stonks only go up.”

This brought to mind one of my favorite books, Reminiscences of a Stock Operator. It is a first person fictional story of a stock trader Jesse Livermore in the 1890s-1920s. The first part of the book covers his escapades at bucket shops, which were effectively places where you gambled on stocks and commodities. Leverage was as high as 100x every dollar you put down and you didn’t even actually own the securities. No fundamental analysis or tax filings required! Just tea leaves and a bit of luck.

History does not repeat itself, but it rhymes. Now today you cannot actually buy a stock on 99% margin due to various pesky securities laws in most if not all jurisdictions. But you can buy options and it is easier than ever. The internet and process automation has brought about a wonderful world of extremely low trading costs and at lightning speed. No longer do you have to call a high-priced trader to place a bet for you. This is unless, of course, you are doing arcane small cap wind up trades like we do here sometimes to our brokers annoyance. But anyway,  add on COVID-19 and now you have a lot of people at home, bored, probably a little down, maybe even unemployed and a bit desperate. Why bother with the casino that’s closed anyway or sports betting. I mean who watches the Game without a crowd? Why not just buy some TSLA calls and be entertained from 9:30-4 until expiry?

This new world of cheap options trading and social media has led to what might be Peak Shenanigans – r/wallstreetbets. It is the land of people investing “for the tendies” and lots of wild stories like this daytrader turning $460 into $1 million – a 221,000% return for those doing the math - through a few Tesla options. Post here - https://www.reddit.com/r/wallstreetbets/comments/k8n3io/1m_from_460_video_so_the_haters_among_you_dont/

Us value investors are staying grounded here at CVI, or at least trying to, and we hope you do to. But maybe the world really is different this time.

I got to keep moving, never gonna slow down

You can have your funky world, see you 'round

I got to ramble

Yeah, I got to gamble

-Bob Segar

Luby’s Inc. (NYSE:LUB) – A Case Study on Valuing Assets in a COVID World

Disclosure: One of us owns this. The author of this piece does not.

To state the painfully obvious, COVID-19 has been hard for a lot of businesses and especially businesses like restaurants. It has caused a lot of failures and follies and individuals to throw in the proverbial towel. One of those businesses is Luby’s Inc.. But when a real-estate-rich restaurant chain decides enough is enough how much are those buildings worth today? In Luby’s case, management says $3-4/share (vs $2.60-2.90 recently). Some say more! Some say a lot less..

A Bit of Background

Luby's, Inc. provides restaurant services in the United States. It operates through five segments: Luby’s restaurants, Fuddruckers restaurants, Cheeseburger in Paradise restaurants, Fuddruckers franchise operations, and Culinary Contract Services. The company operates casual dining restaurants; and offers culinary contract services.

Pre-COVID the Company was already having a bit of an identity crisis when they announced in September 2019 “the formation of a new Board Special Committee and provided an update on several on-going initiatives, strategic operational plans and measures to right-size its corporate overhead.” See here - http://www.lubysinc.com/investors/news/files/LUB%20-Release-9-10-2019.pdf

On June 3rd 2020 the Company announced it was formally throwing in the towel when it “announced it will immediately pursue the sale of its operating divisions and assets, including its real estate assets, and distribute the net proceeds to stockholders after payment of debt and other obligations. During the sale process, certain of the Company’s restaurants will remain open to continue serving our guests.” -

http://www.lubysinc.com/investors/news/files/LubysPressRelease-6-3-2020-Final.pdf

The Wind Up

Here we go! Shareholders approved the wind up plan on November 10th - http://www.lubysinc.com/investors/news/files/Lubys-Press-Release-11-10-2020.pdf

Now there is a lot of information that they disclose in the proxy to shareholders that you should read through if you are interested in this, but for our purposes we will be moving on - https://www.sec.gov/Archives/edgar/data/16099/000121390020030326/0001213900-20-030326-index.htm

Some key points for discussion:

“As of August 26, 2020, we owned 69 properties, consisting of the underlying land and buildings thereon, most of which operate, or have operated in the past, Luby’s Cafeterias and/or Fuddruckers operations. The estimated value of those properties as of August 26, 2020, was $191.5 million (p8)”

“We estimate, assuming the sale of our assets pursuant to our monetization strategy, we could make aggregate liquidating distributions to stockholders, including any pre-effective date liquidating distributions, ranging between approximately $92 million to $123 million (approximately $3.00 and $4.00 per share of common stock, respectively), based on 30,752,470 shares of common stock outstanding as of September 2, 2020.”

Their latest balance sheet is as follows:

Now the core value of the company is the owned real estate. Based on a valuation in the summer they think everything is worth $191.5MM (though you have to be careful of the date they’re using; there have been some post Q2 sales you should adjust for). This compares to a depreciated book value of $104MM and undepreciated (i.e. cash cost) of $249MM. Probably reasonable, or is it?

Valuing in a COVID-World.

On top of untold health and financial damage COVID-19 is making, it is also making it hard to value certain assets. What is a special purpose-built restaurant building worth today? What about in a year? Adding into the fun is lower rates, which is making it easier to finance real estate (depending on the lender’s views of COVID of course).

First up, Seeking Alpha did a piece – “After carefully reviewing the Company’s acquisitions and the real estate in Texas, in my view, $1.85 per share is a reasonable liquidation value.” https://seekingalpha.com/article/4375197-lubys-real-liquidation-value-points-to-stock-price-downside

Hidden Value did a piece in June (pre-Company release) estimating the NAV per share at $2.80, and adj NAV of $2.15 including some cash burn. It also includes a nice gut check of individual properties. https://hiddenvalue.blog/2020/06/26/lubys-nyselub/

But it’s Boom Times Baby!

But deals are still getting done COVID be damned! In the middle of all of this pessimism comes along deals like Inspire Brands bid for Dunkin’ Brands for US$11.3 billion. Chad Finkelstein did a good opinion piece on this -  https://www.theglobeandmail.com/business/commentary/article-the-wave-of-restaurant-chain-mergers-and-acquisitions-in-canada-is/

We have seen enthusiasm for deals ourselves, most notably covered in our recent piece of Front Yard Residential Corp. Their original sale blew up due to COVID-19 but now are getting bought out above their pre-COVID valuation! http://www.canadianvalueinvestors.com/home/2020/10/20/front-yard-residential-corp-nyse-resi-a-quick-crisis-case-study

Free money helps (or at least borrowing for very low single digit percentage points).

One of us decided to buy but this author is staying on the sidelines for two key related issues: Even if you can get comfort with the valuation (say it comes in at the top end of the range), it is challenging to move these types of assets in this COVID market. A rushed sale could lead to lower realized values and conversely more patience means more cash burn to wind things up. To counter that, a bull will say (rightly) that the valuation range provided by management was done mid-COVID and the Company’s entire sale process has been going on during COVID, and so expectations should take that into account. With a bit of scuttlebutt and footwork you might be able to get that range a bit more narrow and a bit more certain. Good luck!

Front Yard Residential Corp. (NYSE: RESI) - A Quick Crisis Case Study

COVID-19 has been a horrendous pandemic and it has caused some very interesting things to happen in the financial markets and our habits. You only need to take a look at Peloton’s stock and pandemic growth (we looked after buying a bike recently.. unfortunately) to see the impact.

A COVID-19 Case Study: The deal that died..?

Back in June we wrote about Front Yard Residential (NYSE:RESI). It is the owner of 14,000+ residential homes that it rents out and at the time was in the middle of a very very angry shareholder dispute. You can see the full write up here - http://www.canadianvalueinvestors.com/home/2020/6/21/front-yard-residential-corporation-nyseresi-covid-kills-a-deal-and-people-are-not-happy-about-it

Pre-COVID it was being taken out for $12.50 a share, but unfortunately the deal collapsed into an awkward equity and debt injection from the acquirer, causing the much hullabaloo we talk about in the June post.

And now… eight months later the Company has found a new deal that values it at $2.4 billion instead of the original $2.3 billion.. with the extra basically going to shareholders through an additional 8% per share.

The uncertainty caused by the pandemic blew up what was supposed to be an airtight deal. Yet the secondary effect of the pandemic is that it made single family residences more appealing and made a portfolio of these residences more appealing to bullish acquirers. So this was more a matter of a stumbling into success story by management rather than a thoughtful plan to get more value.. One of us was in this post-deal failure but out before being acquired – around $9-10 – as this seemed like a conservative fair value (and the shareholder disputes did not help encourage us to stick around).

If COVID has reminded us of anything it is that we always need to ask ourselves “and then what?” What are the possible secondary effects after something happens, particularly a crisis.

The press release:

October 19, 2020 - Front Yard Residential Corporation ("Front Yard" or the "Company") (NYSE: RESI), an industry leading provider of high- quality and affordable rental homes, announced today that it has entered into a definitive merger agreement whereby a partnership led by Pretium and including funds managed by the Real Estate Equity and Alternative Credit strategies of Ares Management Corporation(NYSE: ARES) (together, the "Partnership"), will acquire Front Yard in a transaction valued at approximately $2.4 billion, including debt to be assumed or refinanced. Under the terms of the agreement, Front Yard stockholders will receive $13.50 in cash per share. The per share purchase price represents a premium of approximately 35.5% over Front Yard's closing share price on October 16, 2020, the last trading day prior to today's announcement, and 45.4% over Front Yard's one- month volume- weighted average share price. "We are excited to have reached an agreement with Pretium and Ares Management for the sale of our company, which we believe represents an outstanding, value- maximizing outcome for Front Yard stockholders," said George Ellison, Front Yard's Chief Executive Officer. "Pretium has built an impressive portfolio of single- family rental homes and has developed an industry- leading platform that includes more than 40,000 homes undermanagement. I am confident that the combination of our complementary portfolios, with increased size and scale, operating leverage and efficiencies, will deliver significant benefits to our platform and residents." "The Front Yard Board of Directors has always been committed to maximizing value for our stockholders, and we believe this merger accomplishes that objective."….

Indeed..