I love reading stories about virtually-unknown companies in decidedly unglamorous
sectors which are doing spectacularly well, and the WSJ has a classic
today on a firm with the unhelpful name of M&F. (Would it help if you knew
that stands for MacAndrews & Forbes? Didn’t think so.)
It turns out that M&F, which is controlled by the legendary Ron Perelman,
is doing very well with a very modern strategy. It buys unsexy companies in
old-fashioned industries such as licorice extract and check printing, and uses
the very predictable cashflow from them to raise vast amounts of debt, which
it then uses in turn for more acquisitions. The strategy has helped M&F’s
share price to rise to more than $65 today, from less than $17 six months ago.
So congratulations to the WSJ on finding a stock which really has flown under
the radar and which has some very interesting shareholders. But I’m only giving
the paper two cheers, here, because a lot of the article is very confusing.
There are a lot of numbers in it, but most of them are presented out of context,
in a way which seems designed to make it very difficult to understand what’s
really going on.
I’m not picking on any particular journalists, here: this is something which
happens a lot in financial journalism. But let me just use this article as an
example.
Firstly, the article tells us M&F’s share price, but hasn’t yet told us
its market capitalization. So when we read that a $1.25 billion hedge fund "owns
almost 7% of M&F’s shares," it’s hard to tell how big of a bet that
is. After all, 7% of a $5 billion company is a much bigger deal than 7% of a
company worth $500 million. Later on, we find another fund "with more than
$800 million in assets that owns about 600,000 shares of M&F" –
this is a bit more useful, since we know that the shares are trading at about
$65 apiece, but still we’re being forced to do the multiplication in our heads.
(It works out at about $40 million, or 5% of the fund’s total holdings.)
Then we have to have the obligatory detour into day-trading: "Shares of
M&F, which trade on the New York Stock Exchange, rose 28 cents to $66.38
in 4 p.m. composite trading yesterday." The intraday movement of the stock
price is completely irrelevant to the story, and no reader of this story cares
about details such as "composite trading" – a bit of financial
arcana which serves only to make a lot of readers feel stupid because they don’t
know what it is.
And then we immediately segue into a torrent of ratios and numbers relating
to the company:
The shares currently trade at about 37 times last year’s earnings per share
of $1.82, compared with a price/earnings ratio of about 17 for the overall
market. Noncash expenses related to acquisitions have taken a toll on per-share
profit.
But M&F’s cash flow — money left over after all expenses are paid out
— is impressive: M&F had $116 million of free cash flow at the end of
the first quarter, according to data company Capital IQ, a figure that represents
more than 8% of M&F’s $1.4 billion market value. It has $2.4 billion of
overall debt.
"M&F is one of the cheapest valuations to free cash flow you can
find," says Mr. Teitelbaum, who predicts M&F will generate $10 a
share in free cash flow in 2008.
You basically need to be a stock analyst with a calculator at hand to really
understand all this. There’s a p/e of 37, which seems high, but only, it would
seem, because the denominator is low due to "noncash expenses". No,
I have no idea what those might be. So is the p/e ratio a useful indicator or
not? And if not, why are we comparing it to the overall market as though it
is?
Never mind, we’re on to "cash flow". What’s that? It seems to be
a broader measure of income than earnings, but it’s also money left over "after
all expenses are paid out". Whether that includes those "noncash expenses",
whatever they might be, is unclear. In any case, it turns out that M&F’s
cash flow is 8% of its market value, which compares to the p/e of 37. Or, rather,
it doesn’t. You could talk about a price-to-cashflow ratio of 12, which would
compare. Or you could say that earnings were 2.7% of the company’s market value,
which would also compare. But most people reading the WSJ can’t do those kind
of sums in their head.
In the space of two paragraphs with less than 120 words between them, this
story hits us with no fewer than ten different numbers. That’s far
too many – and the fact that most of them aren’t even helpful just makes
things worse. Yes, it’s good for financial news articles to be quantitative,
when such things matter. But first and foremost, they should be clear and easy
to understand. And this kind of thing simply isn’t.
We then have to hop nimbly over an "overall debt" figure which seems
unrelated to the rest of the numbers, before coming up short against a target
of $10 per share in free cash flow next year.
Now, let’s see. The company has a market cap of $1.4 billion, and it’s trading
at $66.38 per share, so $10 of free cash flow would be 10/66.38 times $1.4 billion,
or – let me get out a pencil and paper here – about $211 million.
In 2008. Which compares to $116 million at the end of the first quarter, which
would be an increase of – hang on one sec, 211 minus 116, divided by 116
comes to 82%. But is that an increase over three quarters or over seven quarters?
That’s not obvious. Oh, never mind.
Eventually, we get to the interesting stuff about the company’s strategy, and
management, and all that kind of thing. But there’s absolutely no reason why
we have to wade through all this dense and very difficult to understand financial
information in order to get there. One or two carefully chosen figures, which
illuminate rather than obscure the situation, would be great. But this is just
a great solid mass of numbers, most of which are presented outside any kind
of useful context.