The Elephant Fund

Oh, Expedia…I think she's still worth the trouble. Here are a few quick thoughts why.

Thesis tested, again

Priced attractively given recent guidance

"Each Stockholder EXPEZ warrant entitles its owner to purchase 0.969375 shares of Expedia common stock at an exercise price equal to $11.56 per warrant. The exercise price must be paid in cash. Each Stockholder EXPEZ Warrant may be exercised on any business day on or prior to February 4, 2009."

Unfortunately, warrants are not the same as call options and have to be valued differently. I don’t know how to value warrants explicitly, but I found a useful model online. The price curve implies a value of $5,05 – 6,35.



Seeing that the online model was close to the Black Scholes value, I rounded my estimate to $5,50. EXPEZ has recently been trading around $4,40.


Outlook

I can’t tell you where we head from here; I see few near-term catalysts. Any short-selling here would be unwise given that EXPE has real assets that produce cash and have the potential to surprise the market as much to the upside (Nov. 2005) as to the downside.

I’d love to know what Bill Miller and Legg Mason are doing with their shares these days. If MMs continue to unload, I’d expect continued weakness in the near-term. Following two earnings misses, most buyers have left the building.

Good luck,

RMA

# posted by RMA @ 08:12 2 comments

Still stinging from EXPE's impressive-(ly bad) Q1, I've been investigating various pain treatment options. Sure, your OTC analgesic might relieve the afternoon headache or Jack & Coke hangover, but stock market pains sometimes need a little extra... like an implantable morphine pump.

Fortunately, the good people at PainCare Holdings (AMEX: PRZ) offer just that. PRZ is a healthcare services company specializing in the treatment of pain. They offer pain management care (to treat chronic or acute pain), minimally invasive outpatient spine surgery, and orthopedic rehabilitation. The Pain Management field is increasingly becoming an important component of patient care and PRZ is a fast-growing provider of these services.

PRZ is attempting to roll-up the Pain Management industry by acquiring high-performing practices, expanding their service offerings, and increasing practice revenues and operating profits by 25-50%. To be clear, the consolidation strategy aims at capturing revenue synergies, not leveraging the cost base to achieve a scale advantage. Given that physician salaries comprise most of the cost bar, I believe PRZ sees limited opportunity on the cost front.

Preliminary results have proved successful. Since 2003, PRZ has increased revenues and operating profits by more than 400% to 69M and 15M, respectively.

BUT, of course there's a 'but':





Just a few weeks ago, the SEC took issue with PRZ's treatment of some non-cash, accounting charges and the stock plummeted by more than 50%. The revisions are an absolute mess and incredibly difficult to weed through. However, I honestly believe they are the nature of the beast and not Management's attempt at disguising the truth. They are all non-cash, non-operating and deal with the accounting treatment for cash-less stock options, debentures, PIPEs, & warrant financing instruments, and intangible asset amortization. The Company has been working hard to revise the financials and is expected to submit their 2005 10K by June 2nd. Most of these issues will persist through Q2 2006.

So, here's the investment thesis.

• Treatment volume will increase: 75M * (1 + 30%) * 'X' Higher incident rate
• Healthcare costs will increase (a given, I think)

Management has successfully executed... and ....Management has unique experience in...
Reviewing the 10K, management biographies indicate a wealth of experience in Healthcare, Industry roll-ups, Pain management, and Mergers & acquisitions.



In addition, PRZ has brought on board a six-person deal team to integrate each practice as it comes online. The acquisition process is methodical and well-tested with more than 20 acquisitions completed to date.

• Clear business definition: PRZ has acquired and continues to acquire high performing Pain Management, Spinal Surgery, or Orthopedic rehabilitation practices. These businesses rank highly on both customer and cost sharing.
• Attractive targets are abundant: American Academy of Pain Management has 6.600 members. Assuming 3 members per practice and that only the top 25% are high-performing (e.g. 80% gross margins, 25% cash operating margins), there are at least 550 potential targets.
• Merger terms are replicable: Almost every PRZ acquisition has been identical. PRZ pays 5x operating earnings with 50/50 cash/equity consideration with earnout agreements spaced from one to three years.
• Consolidation captures synergies: Organic revenue and operating earnings growth for acquired practices trends between 20 and 50% in the first two years after acquisition.

• I think the stock has shown a lot of weakness as persons familiar with PIPE transactions may have anticipated the SEC announcement and shorted the stock ahead of time.
• Investors often shudder after missteps by small-cap companies causing share prices to overreact.
• The non-cash accounting losses are ironically exacerbated by the appreciation of PRZ shares during those time periods (e.g. share price goes up, derivative instrument losses increase as well). As the share price has dropped precipitously in Q1 2006, PRZ is going to announce a monster (great) Q1 that might attract a lot of momentum investors providing the catalyst for the share price to gap upwards.

# posted by RMA @ 06:25 4 comments

Would you buy a dollar for 50 cents? How about a brewery on sale for liquidation prices?

Redhook Ale Brewery (HOOK) makes beer, and good beer at that. Their most popular brews include their own Redhook ESB and India Pale Ale as well as Widmer Hefeweizen (a contract brew for Widmer Brothers).

Yet, great products don't always make great companies. For the last five years, HOOK has been stuck in the proverbial 1st (more accurately, reverse) gear while earning net profit margins of negative 3-5% and experiencing a 4% annual sales dollar decline. HOOK's lackluster financial performance has coincided with an almost 90% cumulative decline in share price since it peaked in the late 90s. Has this been warranted?

Maybe, maybe not. While there are a number of explanations for sales decline and profit performance (sales team restructurings, new distributor agreements, brewing capacity utilization), I'd like to fast-forward to the valuation. I'll let you do your own reading of the company's 10K -- I've already done mine.

At a first glance, Yahoo says that HOOK is currently trading at ~50% of book value. In other words, you or I could buy $60M worth of assets for $30M. I often like to take a closer look at the balance sheet to see what's really under the hood. Below, I've detailed how I would estimate the reproduction cost of the assets.



I see no reason to adjust the current accounts and the only adjustment for fixed assets is to take into account the land appreciation of the Washington facility. Assuming 4% annual appreciation (covers inflation and minimal asset value increases), I estimate BV at $73,5M or $9 per share.

• What would an industrial buyer pay for similar assets?
• What could be a catalyst for the stock to converge on BV?

As for the first data point we don't have to look very far (2005 HOOK 10K). As a matter of fact, as part of a distribution agreement between HOOK and BUD, BUD assumed a 33,6% position in HOOK common stock. Moreover, BUD valued the interest at $8 a share (or 100% premium to today's price).



Given BUD's economic interest in HOOK, I feel pretty comfortable with my an $8-9 intrinsic value estimate for HOOK shares. Now, what could catch Mr. Market's attention to realize that price?

If HOOK could just muster up some profitability, I think investors would reward the stock. And, I think Management is working towards this goal. Since 2001, EBITDA margins have improved 300 basis points to 6,8% and HOOK turned free cash flow breakeven-to-positive in 2005.

Management has offloaded most sales & marketing responsibilities (while conceding gross margin) through the use of distributors (e.g. BUD, Craft Brands) and seems to be improving plant utilization through contract brewing agreements (e.g. Widmer Brothers). Those actions have reduced COGS / unit and improved EBITDA margins. In addition, they re-launched the brand in 2005 and preliminary results are positive.

To summarize:

• HOOK is cheap, really cheap.
• Budweiser, the King of Beers, thinks HOOK is worth $8 a share.
• Profits are improving, albeit slowly.

# posted by RMA @ 13:14 3 comments