More on FLO:
It appears that the market now values FLO ex-KBL stock at about 19M. This for an enterprise that brought in 1.55 billion in sales last year, and possesses quite a few brand as well as distribution advantages.
The catch: Flowers ex-Keebler is responsible for about $550M - or about 5 1/2 bucks per share -in debt, and must come up with somewhat above $40M each year in order to make its interest payments. It cannot access Keebler's cash flow, which brings us to problem number 2 - Keebler has supplied virtually all the operating cash flow reported by Flowers in the first six months this year. Take a more normal year, like say 98, and FLO ex-KBL EBITDA is about $178 million. Cap ex is somewhere around $100 million - reading back through Flowers SEC stuff, it appears to be capital intensive business. Surprise, surprise. The coverage is there, but it really is not a wonderful business for equity holders. ROA is no better than industry averages if you don't count Keebler. For 99, there's nada.
Earthgrains trades at a PSR of 0.49, and Interstate Bakeries trades at a PSR of 0.49. Both have debt/equity ratios of about 1/2 of Flowers ex-Keebler. Allowing for the debt, my estimate is that Flowers equity should trade around $200 million. I get this by applying a 1/2 sales multiple to 1.55 billion, then subracting out the debt of $550M, and reconciling this with an industry P/B of about 2 when not depressed- which would give a total market value of about 720 million - and again subtracting out the debt. Also I looked at free cash flows of about about 40 million available to shareholders after interest and taxes in a typical year, and put a 5-6 multiple on that. This tells me that Flowers equity ex-Keebler should trade for somewhere between 170 and 240 million. Compared to 19M now.
So properly executed, an arbitrage could be very profitable if the market cooperates. One just has to get over the idea of shorting the fastest-growing portion of Flowers, and be confident that Flowers won't face any kind of liquidity crisis that would cause the company to sell out its equity holders.
Lesson learned: Initially I missed the fact that Keebler is little more than a share price floor for Flowers shareholders, as its cash flow is really not accessible. I underestimated the risk of FLO equity going to zero and overestimated the margin of safety as a result. What I thought was a 10-minute no-brainer wasn't. |
