Outerwall (OUTR) is a company you probably haven’t heard of but have probably made use of at least once. Formerly known as Redbox the company changed its name to Outerwall in hopes of not being so closely connected with an obviously dying medium. You should be aware that DVD rentals probably aren’t going to exist in 10 years, and the vast majority of Outerwall’s sales are generated by DVD rentals.
Outerwall’s business consists of two divisions, Redbox and Coinstar. Redbox operates the eponymous automated DVD rental kiosks in McDonald’s and grocery stores throughout the United States. Coinstar operates automated coin changing machines. Both lines of business seem destined to dissappear within the next couple decades, though I admit I can’t see Blu-Ray’s lasting even that long. Roughly 80% of sales are produced by Redbox.
An optimistic valuation in my view is that Coinstar revenue is basically flat for eternity and Redbox’s revenue disappears smoothly over the next five years or so. If we assume that corporate costs stay the same for eternity (obviously this isn’t true but they could go either way, so that’s why we’re using an estimate), we can combine the corporate costs and Coinstar’s net income to come up with an annuity of roughly $26 million. If we discount this annuity at 10% (chosen as a rule of thumb, be careful about this, it could have substantial changes to the current value). This gives Coinstar a value of $260 million. We then add in the value of the cash which can be extracted from Redbox before it’s inevitable demise.
I assume that the depreciation, direct operating costs, and marketing costs shrink along with revenue, I figure that other costs stay stable. I discount this these values at 10% annually as well. Based on these assumptions, I figure that Redbox is worth $475 million if management absolutely nails the moment to quit. Together, this makes me figure that the business is worth $735 million (roughly $45.35 per share) in total. Current valuation of the business is $835 million.
Apollo Funds has offered to buy the entire company, for $52 per share. They have made a tender offer which expires at the beginning of September and if you participate in the tender offer (by instructing your broker to tender your shares) you will probably also get paid within a few weeks of September 1st. At that point Apollo will use its newfound voting power to buy the remaining shares at the same price $52 per share. In order for the deal to go through more than half of the shares need to get tendered to Apollo in the tender period.
Given that Outerwall currently trades for just about $52 ($51.86 as of this writing) a share you might be wondering why in the world you’d be willing to buy it only to get a microscopic gain come September. As it turns out that’s a little bit of a trick. If you purchase the stock on or before August 19th you will also get a $0.60 dividend. Therefore should the company get bought out you’ll get your $0.14 and a $0.60 dividend. This will be a 1.5% gain over the course of a little less than a month. Annualized that works out to 18%, a respectable return by any measure. However, you have to weigh that against the downside that the deal might break and you’ll be left with your Outerwall shares which I consider to be worth about $45, so this break would represent a downside of 13%. In order for this to have positive expected value you’ve got to be thinking that the chances that this deal goes through are about 10x the chances that it breaks.
Additionally, there has been a bevy of legal interest and at least one lawsuit filed on behalf of the shareholders questioning the deal price. There is a small chance that either Apollo Funds raises the buyout price or another buyer comes in with a better price. Without this possible upside Outerwall at this price probably isn’t worth the risk. This is probably no more than a 5% scenario, but the additional possible buck or two adds a significant amount to the expected value that you shouldn’t ignore.
The real opportunity is that the deal breaks. If that happens the price will probably fall substantially as everyone heads for the door at once. This would be an opportunity to make some easy money if the price falls far below intrinsic value. I own shares of Outerwall, and am not adding in order to pick up the possible 1.5% gain (which given the tight time period probably doesn’t need to get scoffed at). But I will probably add to the position by buying either their bonds or stock depending on which gets knocked more out of whack. Outerwall is obviously going largely out of business in the future, but someone is going to extract a great deal of money from it between now and then.
Disclaimer: I am long OUTR (This means that I own Outerwall stock, or that I profit when the stock goes up. Short would mean that I profit if the stock goes down.). I have no plans to buy or sell any of the mentioned stocks within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
The stock that makes the most sense for me to own isn’t a stock at all. It’s an ETF. Basically, it’s a fund that trades like a stock. This fund (XIV) is designed to exploit the fact that people don’t like risk. That makes sense. Risk isn’t a good thing. I don’t like risk, and you shouldn’t either. Some people, have decided that volatility and risk are the same thing. To me, risk means losing my money. Volatility is a measurement of the change in the quoted value in your portfolio.
Okay, so what?
The beautiful thing about the free market is that when someone is willing to pay for something you can offer to provide it. Since I don’t mind the volatility people can simply pay me to take it on. XIV is a method for selling your willingness to accept volatility.
How much volatility?
The answer to that question is lots! In the past XIV has lost over 90% of its value! There is even a provision in the fund which will cause the fund to liquidate if it loses too much value too quickly. This could certainly result in losing 100% of your investment. Why is this level of volatility worth accepting? Well, since inception in late 2010 it has returned 274%, compared to 107% including dividends from the S&P 500.
So how does this literally work?
Mind you, this will get slightly technical, so bear with me. It’s really necessary to fully understand anything that you’re going to invest in and the XIV is no exception. In order to understand the XIV etf you must first understand the index it attempts to short (ie, be the opposite of).
The VIX is a volatility index. It attempts to measure how much risk there is in the market, by measuring how much the market expects prices to go up and down over the next month. In the context of the VIX, “the market” means the S&P 500. The index itself is calculated from the implied volatility of both calls and puts on the S&P 500 index. Prices of calls and puts both sooner than one month from now, and after one month from now are used to interpolate the volatility over the next month. For a step by step explanation of how to calculate the VIX yourself, please see the Chicago Board of Exchange’s white paper on the subject.
The calculation is designed so that a VIX index level corresponds to an annualized expected percentage change in the market over the next month. So if the VIX is 36 that means that there is an expected 3% (36% / 12 months in the year) change in the market over the next month. Higher VIX levels correspond to expectations that the S&P 500 will change by larger amounts.
It isn’t immediately clear from that why a fund based on doing the opposite of the VIX would make money. Well, if you had a fund that wanted to mirror the VIX, you’d have to own a bunch of options on the S&P 500 at different strike prices. These options have expiration dates, and you need to maintain a weighted average of options exactly 30 days into the future. So, as each day goes by, you have to buy enough options with expiration dates more than 30 days away, and sell enough options with expiration dates closer than 30 days to keep your weighted average exactly 30 days away.
This means, on average, you’re selling options with nearby expirations, and buying options with distant expirations. Generally the future has more implied volatility than the present because there is simply less known about the future than the present. This means that the value of options tend to decay as days go by, and therefore a VIX fund loses a little bit of money, on average, each day. Since inception in 2009 a VIX fund (VXX) which attempts to match the daily change in the VIX has lost 99.9% of its value.
The XIV does the exact opposite. Rather than buying these options, it sells these options, so it, on average sells options with distant expirations and buys options with nearby exipirations. Therefore, you should expect the XIV to make a little bit of money each day, on average. As I mentioned before, since inception XIV has gained 274% in value.
So therefore what
Well there’s a real chance that this guy will go to zero. I wouldn’t put all of your money into it. I keep a very small percentage of my investable net worth in XIV. I put a little more in everytime the world loses its collective mind (Brexit, US Goverment Shutdown, the Euro Crisis). If it ever becomes too large a percentage of my portfolio 4-5%, I plan to sell it back down to 1-2%. This breaks my cardinal rule of never selling, but I’m not sure that XIV will ever pay dividends, and the continued risk of going to zero seems non-trivial to me.
Global poverty is not something recently invented for the benefit of multinational corporations.
~Paul Krugman (Nobel winning left-leaning economist)
Globalization has been wildly good for the world, in particular it’s been good for the poor. It’s interesting because most Americans, 67%, believe that global poverty has increased over the last 40 years. Fortunately for the world, this just isn’t true.
In my view sweatshops are terrible soul crushing places, the faster the world is rid of them the better.
You would be very mistaken however, to think that sweatshops cause poverty. Sweatshops are a symptom of poverty, and poverty will not be cured by removing the cause. For example, one of the worst places to work is undoubtably in a Nike factory in Bangladesh. Unless you live in Bangladesh, there a job at a state owned factory pays only a third of what a Nike factory worker can make. It’s easy in the west to simply say, “well that’s still unfair, it’s still too little. Nike should pay more”. That’s easy for privileged westerners to say. If Nike then moves out of Bangladesh and stops using sweatshops we will pay a little more for sneakers.
I don’t know anyone who says they would be unwilling to pay more for sneakers to improve the lives of the Bangladeshi. Paying more for sneakers wouldn’t hurt middle class Americans much at all, and really, why should we care about how much middle class Americans pay for shoes when the vast majority of the world lives in terrible poverty? But, if Nike moves out of Bangladesh, it won’t be middle class Americans who will truly suffer for it. It will be the Bangladeshi.
Take this example from Nicholas Kristof about the people in Cambodia who scavenge a garbage dump for recyclables:
Talk to these families in the dump, and a job in a sweatshop is a cherished dream, an escalator out of poverty, the kind of gauzy if probably unrealistic ambition that parents everywhere often have for their children.
Vath Sam Oeun, hopes her 10-year-old boy, scavenging beside her, grows up to get a factory job, partly because she has seen other children run over by garbage trucks. Her boy has never been to a doctor or a dentist, and last bathed when he was 2, so a sweatshop job by comparison would be far more pleasant and less dangerous.
Americans have a very selfish view of this, many would harm their country and others to end globalization and tear up trade agreements. They’d prefer this sort of thing to continue instead of sweatshops because then they don’t have to feel morally responsible for it. Refusing to help other people at your own expense isn’t nice, but it is normal behavior, and it is occasionally defensible. Injuring yourself to do real harm to other people, and then pretending not to notice the harm you do is the most morally reprehensible thing I can think of.
Buying Local; Supporting Global Poverty
This, in a nutshell, is why I think that buying local is just about the nuttiest thing I’ve ever heard of. Paying more for a good, not because it’s quality is higher, but just because it happened to be made nearby impoverishes everyone, but the poor of the world most of all. Putting the global poor out of work so that you can feel morally superior supporting someone with a college education making fancy doilies seems crazy to me.
But, buying local keeps the money in the community!
You have fallen prey to the money illusion. The standard of living of a community is determined by what it produces not money that it has. The problem with your reasoning is made obvious if you extrapolate it. If a community is made better off by buying worse goods preferentially from each other, would the community be better off if everyone paid each other all of their money for spending all of their working hours producing the shoddiest good of all, nothing. Your community would quickly starve. Whenever someone is trying to convince you of their economic argument by paying attention to money rather than the actual goods and services, they do not understand economics.
If you think that your local producer of a good makes it better, that’s great, buy it. If the goods that you buy local are equally good for the same price, then there’s no need for the inducement to buy it locally! The degree to which the goods you purchase locally are worse, or overpriced (I generally find that a local good commands a 100% markup over its equivalent), is the degree to which you impoverish your community by buying them.
It’s very hard for Americans to understand real poverty. Everything so much poorer than us looks equally wretched and miserable. The only important question in this debate is, what will most quickly bring global poverty to an end. I’m sorry you don’t like that globalization and its attendant sweatshops are the only answer, but they have reduced poverty at a rate faster than has ever been seen in the history of man. Many other things have been tried, including just giving people more money. They don’t work. Wishing won’t make it different. Refusing to understand doesn’t improve the situation. Sweatshops are dirty, miserable and dangerous, but they are their own cure.
This is one of the bigger companies that I’ll profile here. It has a market capitalization of about $75 million. Huge in comparison to the sub-10 million dollar companies we’ve been discussing. The trick to Richardson Electronics is explained far better by Danny DeVito than I:
Why Does Liquidation Value Matter?
“Alright”, you might say, “but if Richardson doesn’t liquidate, why does the liquidation value matter?”
That’s a good point, this is the whole unproven bit of the theory behind value investing. If you could sum up value investing in one sentence it’d be, “Shares of a company are worth what a private buyer would be willing to pay for the whole company divided by the number of shares outstanding.” So what does that mean?
If a private buyer would be willing to pay $110 million for Richardson Electronics, then we should divide that by the number of shares outstanding (12.5 million), then the theory of value investing suggests that the fair price for shares ought to be about $8.80. This would leave us with roughly 50% upside for Richardson.
Why should a company be worth what a private buyer would be willing to pay for it? Well, there’s not a good answer. Other than, the statistical evidence seems to bear it out.
What would a private buy pay for Richardson Electronics?
Well, that’s a better question. I value Richardson Electronics’ cash, inventory, and net receivables at full value. There are perhaps arguments that this shouldn’t be the case. Perhaps some of the cash deserves a 20% haircut for being overseas and it is therefore still taxable if brought back to the US (suppose a 10% haircut on all of the cash, as maybe half of it is overseas). The net receivables maybe get the same discount plus a little because there is counterparty risk (say 15%?). Perhaps some of the inventory deserves a discount, as they might not be able to get what they paid for it. The inventory doesn’t get the same tax discount as the cash and net receivables because it is held at cost, and is therefore tax deductible. We may want to give the inventory a haircut, as Richardson might not be able to move all of it just because they paid a certain amount for it.
If you toss all of that in a spreadsheet, and subtract off all of Richardson Electronics liabilities at face value, then you figure that even if the operating company was worth $0 as a going concern, at a bare minimum Richardson Electronics would be worth $90 million to you. You would probably want to throw in the $8 million of long term CD’s that the company also owns. The rest of the land, equipment and so on you get for free. So call it an even $100 million, like Danny DeVito, I too like round numbers. So, to a private buyer shares are worth at least $8.
Could anything go wrong?
Very many things.
First off, management appears to be overpaid. The CEO’s base salary went from $630,000 to $700,000 over the last two years, a period during which Richardson electronic’s operating performance substantially deteriorated, and the stock price was cut in half. Including bonuses the full management team made $3 million last year. $3 million is a great deal of money when the gross profit for that year was only $41 million. The actual owners of the company were paid $3 million as well, in the form of dividends over that year.
Why is management so overpaid? Well, management’s is the only vote that actually counts. Richardson electronics has a special share structure which allows the CEO, Edward Richardson, to control a majority of voting power in the company despite only owning about 20% of the company’s stock.
There are two classes of shares, A and B. The B shares have 10 votes, while each A share only gets one vote. The B shares do only receive 90% of the dividend and have rights to only 90% of the earnings that the A shares do, but are convertible into A shares at any time.
This means that the CEO wins every vote that matters, and should a private buyer make that fair offer to buy Richardson Electronics the CEO can simply say “nope, I’d rather keep my million dollar per year salary.”
This might mean that management could continue to run up losses, and burn through the net cash, receivables and inventory we are counting on to give value to the company. This could certainly go to zero, and it’ll be a long painful slog to get there.
The Ray of Light
On the upside Richardson Electronics is slowly liquidating. They pay out $0.24 in dividends every year, giving RELL a 4% yield. In principle this could continue until they paid out all $8 of value in the company, or the company returns to profitability. This means that investors don’t merely have to sit on their thumbs and hope for the best, and they probably won’t end up with nothing to show for their investment. All in all, I think Richardson is a strong bet.
Disclaimer: I am long RELL (This means that I own Richardson Electronics stock, or that I profit when the stock goes up. Short would mean that I profit if the stock goes down.). I have no plans to buy or sell any of the mentioned stocks within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
The best place to exchange money is inside your credit card. Sometimes that’s not possible, in which case we’ve got a list of the rest of the places that you should exchange money. Ultimately what you’re worried about here are fees. There are plenty of people out there willing to sell you some story about how they know how to time currency transactions in order to save you money. The financial world is full of superstitions like that, do your best to ignore it. If anyone out there thinks I’m wrong I’d be happy to take a bet on the subject.
Alright, now I’ve said it twice. Just get one without a foreign transaction fee and call it a day.
High Yield Checking
There are a few high yield checking accounts out there. The basic idea for these is that you jump through a few hoops and the checking account pays you an above market rate of interest (up to a specific balance) and will often reimburse ATM fees. I recommend Consumers credit union. The requirements usually involve using the debit card a dozen times in a month and setting up direct deposit. The interest rate alone is generally worth it, but using it to change money from foreign ATM’s is the icing on the cake. Whenever I need cash abroad I just get it from a random ATM, knowing I’ll be reimbursed.
Your Local Credit Union
You should probably be a member of your local credit union. In principle the profits from the credit union flow to you rather than to shareholders. Generally this means that all kinds of things are cheaper at the credit union. Of course because they don’t have to look after their profits sometimes bureaucracy can get a stranglehold on your credit union and the fee schedule might not make any sense from any perspective, so it pays to check that your credit union is actually giving you a good deal.
What’s a good deal? Whatever google tells you the exchange rate is, basically.
Also, as a bonus your credit union may eventually convert to a bank, in which case you’ll have an opportunity to make money in its conversion. (You see, the owners of the credit union are its customers, when it converts to a bank it will be owned by shareholders. To convince current owners, that’s you, to do the conversion the credit union needs to offer you something valuable. Usually, that means you can purchase stock at a discount. That’s a fantastic deal. Your credit union probably won’t do this, but it’s essentially random upside. )
Your Local Bank
Usually you can order foreign currency, online or by phone, in advance from your bank and get a good rate with a minimal fee. If you show up at the teller demanding Euros you’ll probably get a rate that’s not quite as good.
Their Local Bank
It’s not going to be a great deal to do this, and I’d anticipate it to be somewhat worse than your local bank, but your mileage may vary. (That’s what YMMV means if you ever see it on line. That’s one I have to look all the time. That and TFW, or SMH.)
(That feel when, and shaking my head, respectively)
(I can’t imagine saying either of those things so often that you’d need to abbreviate them, but TYHI.)
(There you have it; That one’s not real but what are you going to do?)
Buy Euros From American’s leaving the country
They need to get rid of their foreign currency, you need the foreign currency. You can probably get the fair rate, since either of you are going to get screwed at your destination.
These places exist mostly in tourist spots. They’re pretty universally awful, only use in an emergency. Alternatively, send your enemies there.
Don’t have enemies? You will if you send people here to change their money.
Cash Exchange at the airport
This is good for when all of your foreign currency gets stolen, as well as your atm card, but you still have a roll of $100’s in your sock. Change just enough to get you to the nearest bank, or some other place that will repair your problem. Even then you might be better off begging other american’s for bus fare, or hanging out near the forex place looking for people who look like they’re departing the country.
Fortune industries is a Human Resources company. Basically small to medium sized companies outsource their human resources department to Fortune. Why talk about them? Fortune Industries is the cheapest company I know of on an earnings basis (excepting cases where the business is obviously in sharp decline, like Outerwall). I’m sure there are cheaper companies out there, but Fortune has a special history.
What happened at Fortune
The CEO of Fortune Industries had some money trouble back when it traded under the ticker FFI. He had put up his shares in FFI against a personal loan. Unfortunately, he couldn’t pay that loan and it looked like the bank was going to foreclose on the shares. The company didn’t want to be majority owned by some random bank, so they sprang into action. Management formed another company CEP, and used this company to do a buyout of Fortune Industries.
Long story short, somehow, the number of shares outstanding went from about 12 million to 55 million, existing shareholders were substantially diluted. As far as I can tell all the company got in exchange was cancellation of the preferred stock, which in my view, was not worth 80% of the company. Management got majority ownership of the company for a song, I can only imagine it was this one:
I sincerely hope they had to sing it before getting the company handed to them. Fortunately (I see what I did there*), the company would borrow a bunch of money and buy out small shareholders for $0.61 per share.
The trick to this was that only shareholders who had bought before a certain date would get bought out. When this was announced the stock price of Fortune Industries collapsed. Arbitrageurs considered this an opportunity, they could buy shares for Fortune for about $0.15 figuring that the company would have to buy them out even if they didn’t make the date in order to get the number of shareholders below 300 (the maximum number of shareholders a company can have before it can no longer be considered “private”).
This didn’t actually happen. Fortune and a bunch of shareholders who thought they were going to get a free double or triple were instead stuck with shares that simply could not be traded. This continued for months as the untradable shares sat in the brokerage accounts of people sure they were just going to make a quick buck. In the meantime fortunes operating results, under the heavy debt load, stayed stable. The company continued to grow.
Roughly a couple years ago the company was able to get listed under the symbol FDVF. All at once the arbitrageurs attempted to sell. This pushed the price down far below where it was before it went private, despite the fact that operating results had been improving.
Over the years since going private Fortune Industries has seen mostly growth. The company is highly leveraged, so increasing revenue has helped earnings substantially (going from operating profit of 2.5 million to 4.3 million over the last three years, adjusted for non-cash compensation from CEP, and a goodwill writedown in the initial year). Earnings have been used to pay down debt, which currently has an interest rates ranging from 5.75% to 10%. Paying down this debt essentially gets the company an immediate ROI equal to the interest rate. This is extremely good when the company also has organic revenue growth on top of that.
This investment has some issues with it. For one part, small shareholders are certainly just along for the ride. Management owns over 90% of the company. It’s probably more efficient for them to take profits in the form of greater pay rather than dividends (management compensation is generally tax deductible at the company level, while dividends are not). This merits keeping a very careful eye on management compensation. Unfortunately, it isn’t at all clear to me how one could keep an eye on management compensation. The figures aren’t public. It does appear that there is some sort of earn-out for management from the controlling company CEP, and management will earn about $2 million in restricted stock over the next 5 years, not from the owners of Fortune Industries, but rather from the owners of CEP (this should probably be read as, the previous CEO Marc Fortune).
The real hair is that, in my view, this management team already stole the company. Maybe they’ll do it again. I can’t think of any reason for them not to. The money maximizing route for management at this point is to sit on their majority ownership of the company and vote themselves salary increases. There aren’t any members of the board which aren’t also members of CEP. The only member of CEP which doesn’t have an incentive to simply vote for salary increases is Marc Fortune.
Flatly, the company is inexpensive. It last traded at $0.29 per share, and over the last 12 months it’s earned $1.96 million. The number of shares outstanding is about 55 million. This works out to earnings of $0.035 per share. That leaves us with a price to earnings of about 8. This would not be so impressive, unless we looked at the fact that the q4 from the previous year I’ve excluded as it includes a non-cash compensation charge that appears to be non-dilutive. I estimate that the actually P/E is closer to 6. In my view that makes up for a great deal of problems. I’m not currently long Fortune Industries, but if the price to earnings drops near 4 or 5, I would definitely pick some up. I think that over the course of the next few years, barring any recessions, earnings will probably grow at 8-12%. I estimate that this is roughly the return a holder of Fortune Industries would see over the next few years. Barring, of course, management just stealing the company again.
You might be inclined to think that I would advise against buying and holding this company. After all, a company can double any number of times you like, if management leaves with everything at the end, who cares? That’s a fair point, but I think that while it is possible that something like that does happen, I think it’s relatively more likely that the company just grows and pays down debt. There is no incentive for the company to pay a dividend, but if you have a long-term time horizon I think that eventually something good will happen. I don’t know what (maybe a buyout), and I don’t know when (5 years), but buying companies at a price to earnings of 6ish will probably be good if you have a basket, and you’re willing to sit.
Disclaimer: I have no positions in any stocks mentioned, and I have no plans to buy or sell any of the mentioned stocks within then next 72 hours. I wrote this article myself, and it expresses my own opinions. This is not a recommendation to buy or sell any stock. I am not receiving compensation for it (other than from the owner of the blog District Media Corp). I have no business relationship with any company whose stock is mentioned in this article. Always do your own research before making any trade, buying or selling any stock mentioned.
*It was a pun.