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Graham & Doddsville - Issue 32 - VFF 25-Jan HARD
Graham & Doddsville - Issue 32 - VFF 25-Jan HARD
Bruce Greenwald and Mario Gabelli ’67 David Abrams and Bruce Greenwald at
prior to the keynote address and the 27th the 27th Annual Graham & Dodd
Annual Graham & Dodd Breakfast Breakfast
VolumePage
I, Issue
3 2 Page 3
TBU TBU
The keynote topic was the future of value investing—heavy stuff CBS Professor and Co-Director of the Heilbrunn Center Bruce
for breakfast conversation Greenwald, keynote speaker
TBU TBU
Attendees of the 27th Annual Graham and Dodd Breakfast Columbia Business School Dean Glenn Hubbard
TBU
TBU
William von Mueffling ’95, President and Chief Investment Officer, A riveted crowd listens attentively to Professor Greenwald
Cantillon Capital Management, addresses the crowd reassure them that value investing is here to stay
Page 4
Also, by no means is our similarly proven itself in the Meanwhile, consumers who
position predicated on the idea marketplace, precisely because couldn’t get a loan anywhere
that Google is going to there have been other search else get a chance to rebuild
continue growing 20% a year engines that haven’t stuck. their credit record if they’re
for the next five years. I able to pay the loan off, even if
certainly would not want to The Google search engine they’re paying rich terms to
take the over on that bet. Our works better. It’s better for access that credit. Around 60%
guess is that the business is the consumer. And at this of people end up paying the
going to grow in the future, point, it’s so powerful and so loan off. I think it is a benefit to
but the point is that we didn’t widely used globally, it would the consumer. And for the
want to be forced to have an be very, very hard for 40% or so that ultimately end
opinion about the rate of up defaulting on the loan,
(Continued on page 18)
Page 18
Recommendation
We are long Staples 8.5 2025 Senior
Unsecured notes which are trading at
91.7 with a YTM of 10.3%. The mar-
ket has overreacted to the announce-
ment of Amazon Business Prime on
October 24th, dropping the newly
A.J. Denham, CPA ’19
issued bonds from 96 to a low of 85
A.J. is a first-year MBA student in a two week period. We believe the bonds offer a compelling investment due to 1) extremely stable cash
at CBS. Previously, A.J. worked
in private equity at the Florida flows with 70% of revenue on 3-5 years contract basis with 92-97% customer retention rates, 2) strong barri-
Mezzanine Fund then as a ers to entry against Amazon, and 3) market overreaction to Amazon Business Prime.
Manager in Strategic Planning at
Verizon in the U.S. Business Description
Staples is a B2B distributor of office products. The company is the 5th largest e-commerce merchant in the
U.S. Staples was acquired by private equity firm Sycamore Partners on September 12, 2017, and issued $1.0bn
in 8.5% Sr. Unsecured Notes maturing 2025 to finance the transaction alongside a Sr. Secured $2.9bn Term
Loan and $1.6bn in new Equity. The issuer is Staples North American Delivery (NAD), a B2B office supply
distributor. Staples NAD operates three business segments: Staples Business Advantage, which targets enter-
prise customers on a 3-5 year contract basis (70% of revenue), Quill.com, and Staples.com, which targets small
businesses and individuals (collectively 30% of revenue). Sycamore spun off the retail store operations into a
separate entity with its own separately financed capital structure with no cross obligations.
Investment Thesis
1) Sticky customer base with extremely stable cash flows
Staples has extremely stable cash flows with a high fixed charge coverage ratio. 3-year customer retention
rates are 97% for enterprise customers and 92% for middle market customers. These customers comprise
70% of sales, creating strong revenue protection for the entire company.
Kevin Brenes ’19
Kevin is a first-year MBA Staples Business Advantage revenues are extremely sticky. We have modeled a downside scenario with as-
student at CBS. Previously, sumptions of contracts renewing every 3 years and retention rates declining by 3% per year for the next 5
Kevin worked at Banco Gen-
eral as an analyst in Panama
years. These inputs only produce a ~2% revenue decline per year. Because of its stable revenue and approxi-
City, Panama. He covered Latin mately 10% projected EBITDA margins, Staples generates strong free cash flow that covers its fixed charges by
American corporate bonds and over 2.0x. Bringing the FCCR to parity would require assumptions of 50% customer retention rates, a 5%
Panamanian equities. gross margin contraction, and a 17% revenue decline – unrealistic given Staples’ history and barriers to entry
in the industry.
Staples 8.5 2025 (CUSIP: 03939PAA2) - Long (Continued from previous page)
• Desktop Delivery: Staples has a dedicated sales team and delivery fleet that work with office managers on delivery times and place-
ment. Staples consolidates orders, delivers, stocks, and installs merchandise at specific times in specific locations within a building –
for example, directly walking into a customer’s office and installing ink in the printer. By contrast, Amazon sends separate packages
for each order (85% of Amazon Business deliveries are not consolidated by address) and delivers only to customer’s door or mail
room. Corporate clients confirmed the high demand Staples’ approach to enhanced customer service without which it becomes
much more difficult to win request for proposals (RFP).
• Customer Service: Staples assigns each enterprise customer a dedicated sales representative to provide support for personalized
orders and logistics. Staples currently employs 3,500 sales representatives and is planning to add 1,000 more. Amazon does not have
a dedicated office supply sales force and has no experience with the RFP process. This is a critical support factor; individual corporate
sourcing agents have little to no experience planning corporate-wide office supply needs.
• Fixed Pricing: Enterprise customers require fixed pricing on a contract basis. Amazon is unable to provide fixed pricing because
over 50% of its office supplies are sourced from third-party vendors over which Amazon has no control. Amazon’s existing business
model conflicts with current business practices in the B2B office supply industry, and it will be tough for Amazon to change this core
competency.
• Switching Costs: Switching costs such as process integration and retraining personnel are a real consideration for corporate cus-
tomers. Office supplies are also such a small part of the overall corporate cost structure that there isn’t as much pressure to cut
costs, and any gains are unlikely to outweigh the pain from switching vendors. Corporate inertia will delay any effort Amazon makes
to enter the enterprise market.
Capital Structure
Staples debt consists of two issuances: a $2.7B Senior Secured Term Loan at L + 400bps due in 2024, and this $1B 8.5% 2025 Senior Un-
secured. There are no near-term maturities and the Term Loan amortizes at 4% a year, reducing total debt over time. Staples also has
access to a $1.2B undrawn revolver at L + 150bps for liquidity support if necessary. While rated B-, 3.6x EBITDA/fixed charge coverage
and under 3.7x total leverage resemble a B+/BB- profile and will support a rating upgrade with continued strong financial performance.
2) Sycamore sells assets and/or distributes cash: Sycamore has a poor reputation among creditors due to harmful actions in prior
deals. In our model, we assume Sycamore will distribute any of the company’s excess cash and liquid assets in order to enhance its re-
turns, which requires accepting the risk of further assets sales which might erode credit support. This risk is mitigated, however, by the
over 2.0x fixed charge coverage ratio, stable cash flows, and $1.2 billion revolver. You are not buying these bonds for the balance sheet,
you are buying them for the coverage.
Page 23
Recommendation
We recommend a long on
FleetCor Technologies
Aditi Bhatia ’19
(FLT) with an end of 2019
Aditi is a first-year MBA stu-
dent at CBS. Previously, she
price target of $279.46,
worked as a Senior Associate offering 80% upside from
at Temasek Holdings and as an September 2017’s price of
Investment Banking Analyst at $155.00 and an IRR of 34%
Credit Suisse.
over a two-year holding
period. We believe that FleetCor has 1) an attractive business model with strong network effects yielding an
industry-leading ROIC, 2) the ability to grow revenue ~15% per annum over the next 5 years by capturing
opportunities domestically and abroad, and 3) an attractive buy-in opportunity due to misplaced market pessi-
mism.
Business Description
FleetCor is headquartered in Norcross, Georgia, and its products are used in 53 countries around the world,
with its primary geographies in the US, Brazil and the UK. FLT provides workplace productivity enhancement
products primarily related to fuel, lodging, and employee benefit payments, telematics services, and fleet
maintenance management. Fleet card solutions (>60% of revenues) allow fleet owners to control employee
Lisa Chen ’19 spending, generate fuel savings and improve free cash flow. Further, by joining a fuel card network, gas stations
Lisa is a first-year MBA student benefit from increased vehicle traffic. The company’s core products are primarily sold to businesses, retailers,
at CBS. Previously, she worked major oil companies and marketers and government entities.
in Strategy and Business Devel-
opment at BlackRock in New
Investment Thesis
York.
1) Attractive business model with strong network effects yields leading ROIC
The industry is characterized by high barriers to entry because the two interdependent factors for success
include scale and network acceptance, which is challenging for a new entrant to build. The business model is
characterized by highly recurring and diversified revenues with high customer retention, resulting from a
strong value proposition to customers. FLT and its closest competitor operate in a duopoly market following
significant consolidation, and there are no near-term threats from smaller players in the market. Between the
two players, FLT has consistently had a higher ROIC, cleaner balance sheet, and a great execution track rec-
ord.
2) FLT can grow revenue ~15% per annum over the next 5 years by capturing opportunities do-
mestically and abroad
Victoria Gu ’19 We identify attractive market growth opportunities in its two key markets: fuel card market estimated to
grow at 19% CAGR over the next 5 years driven by increasing market penetration, and corporate payments
Victoria is a first-year MBA market estimated to grow at 8% p.a. Using a blended market growth rate across different business segments,
student at CBS. Previously, she
worked as an Investment we believe FLT can achieve a ~15% growth rate p.a. over the next 5 years.
Banking Analyst and Associate
at J.P. Morgan in the US and
Europe covering the TMT
sector.
Aleksandrina Ivanova ’19 3) Market pessimism is misplaced, creating a cheap and attractive buy-in opportunity
Citron published a short interest report in April 2017 accusing FLT of unsustainable fee practices from late
Aleksandrina is a first-year fees and predatory billing practices that were driving away customers and large accounts (Chevron). The re-
MBA student at CBS. Previous-
ly, she worked as an Equity
port was timed with FLT’s ComData IT conversion issue that caused billing inaccuracies and delayed customer
Research Associate at Survey- service to 30K accounts, leading to a significant uptick in customer attrition and precluded new sales. Since
or Capital. Before that, she then, the issue has been resolved and attrition has stabilized. Noise around billing practices has also quieted,
spent 3 years working as a
High Yield Associate at Fidelity.
with stock prices recovering since 2Q17. Upon inspection of FLT business practices, we see consistent above
Page 24
Valuation
We are valuing the company assuming a two-year holding period. In our base case, we assume the multiple would re-rate to competitor
WEX’s current level. In our bull case, we assume the multiple would re-rate to FLT’s level prior to the publishing of the Citron report and
IT conversion issues. In our bear case, we assume the multiple would not re-rate. Taking into consideration all potential outcomes, we
arrive at a FY19 target price of $279.46, which implies a 34% IRR. We also used a DCF as a sanity check to our valuation methods. Based
on current market conditions and comparable beta to WEX, our DCF analysis yields similar price ranges to a multiple-based approach.
NTM P/E multiple evolution: FLT is currently trading at a discount to WEX and its own 5-year avg. NTM P/E
Catalysts
1) Analyst day in 2018 and a new Head of Investor Relations should provide for better management disclosure and correct the market’s
misperceptions.
2) Proven strong customer retention in the coming quarters to counteract Citron’s allegations.
CBS first-year students Jade Hu ’19 ([email protected]) and Ashley Allen ’19 ([email protected]) also participated in the presenta-
tion of the FLT idea at the WIN conference in November 2017.
Page 25
Recommendation
We recommend a long Capitalization Other
on First Data Corpora- Share price ($) $17.1 Short Interest 6.80%
tion (FDC) with an end DSO (mm) 923.5 52-week low/high $13.01/$19.23
of 2020 price target of Market Cap ($mm) $15,819
$39, implying a 128% Less: Cash ($mm) (502) EV/EBITDA FY18E 11.3x
absolute return and 30% Plus: Debt ($mm) 18,649 EV/EBITDA FY19E 11.9x
Ishaan Bhatia ’19 IRR. We believe: 1) Plus: Minority Interest ($mm) 2,938 P/E FY18E 10.9x
Ishaan is a first-year MBA
FDC is a winner in an Enterprise Value ($mm) $36,904 P/E FY19E 9.9x
student at CBS. Previously, he oligopolistic market with Leverage 6.3x FCF yield 8%
worked as a Private Equity industry leading margins
Analyst with Samara Capital in and cash flow, 2) short-term fears are overblown and FDC can grow revenue at 6-8% due to secular recovery,
India and as an Investment
Banking analyst at J.P. Morgan and 3) strong FCF generation will lead to rapid deleveraging and a multiple re-rating to P/E.
in India and the UK.
Business Description
First Data Corporation is the largest merchant acquirer, merchant processor, issuer processor, and network
services provider in the world, with a global footprint on four continents. FDC was taken private by KKR in
2007 and recently went public in 2015. It has three segments: 1) Global Business Solutions (GBS) - POS mer-
chant acquiring and processing, 2) Global Financial Solutions (GFS) - credit/private label processing, and 3)
Network & Security Solutions (NSS) - EFT network solution (STAR), stored value network solutions, and
debit card processing. 79% of FDC’s revenues are from North America, 14% are from EMEA, and the remain-
der is split between Latin America and Asia.
Investment Thesis
1) Winner in an oligopolistic market with industry leading margins and cash flow
FDC’s scale and distribution network are protected by high barriers to entry. Its large network allows FDC to
continuously reinvest cash flow into expansion, driving customer stickiness and cross-selling opportunities. At
1.5x the scale of the closest competitor in merchant processing volume, FDC enjoys the highest EBITDA mar-
Ryan Darrohn ’19
gins (37%) and FCF conversion percentages (92%) in the industry.
Ryan is a first-year MBA stu-
dent at CBS. Previously, he was
an acquisitions officer and
Captain in the U.S. Air Force.
He graduated from the U.S. Air
Force Academy with a degree
in Business Administration.
Victoria Gu ’19
Victoria is a first-year MBA
student at CBS. Previously, she
worked as an Investment
Banking Analyst and Associate
at J.P. Morgan in the US and
Europe covering the TMT
sector.
Page 26
Valuation
Our base case price target of $72 offers ~31% upside. In the base case, we assume:
• Base Case: one-year forward P/E multiple of 18.5x, driving non-GAAP EPS of $2.25/share in FY2021.
• Bear Case: one-year forward P/E multiple of 13x, driving non-GAAP EPS of $1.26/share in FY2021.
• Bull Case: one-year forward P/E multiple of 22.1x, driving non-GAAP EPS of $2.57/share in FY 2021.
Using weights of 50% for the base and 25% for the bull and bear, our implied share price in FY2020 is $39.10, representing upside of 128%
and an IRR of 30%.
categories. Prior to majored in finance and of fun, but the main reason I
founding Vulcan Value minored in English. As my went back to school was to
Partners, C.T. worked as a coursework evolved and as I transition my career. In 1990,
principal and portfolio had exposure to more things, I I started with Southeastern
manager at Southeastern discovered that I was Asset Management in
Asset Management. passionate about investing. Memphis, also known as
During his 17-year tenure, Longleaf Partners. I was very
the team at Southeastern While I was in school in the fortunate there had been some
Asset Management early 1980s, coursework changes in the senior
achieved double digit emphasized efficient markets, management of that company.
C.T. returns well ahead of CAPM, and all those things. It left a hole, allowing some
Fitzpatrick, CFA inflation and was ranked in Conceptually, a lot of it made younger guys, including myself,
top 5% of money managers sense but some of it didn’t. It to take on a lot of
over five, ten, and twenty was counter to how my dad responsibility quickly. I became
year periods according to actually did things in the real a partner in the company
Callan and Associates. world. I started challenging my pretty early on.
professors and I got pushback.
C.T. earned his MBA in It just didn’t feel right. Of I started as a generalist. We
Finance from the Owen course, you want to were finding things in the real
Graduate School of regurgitate it for the test, but estate area that were really
Management at Vanderbilt then do you really agree with cheap and interesting. We
University. He also has a it? increasingly gravitated to it
BS in Corporate Finance simply because there was
from the University of I read Graham and Dodd’s more opportunity there. Long
Alabama. Security Analysis just to try to story short, we started a real
understand, “Okay, what’s the estate effort, and I was very
Graham & Doddsville other side of this?” It really fortunate to be tapped to lead
(G&D): Could you tell us appealed to me and struck a that effort. I went from being a
about how you got started in nerve. By the time I graduated, generalist to a real estate
the industry? I wanted to be a value expert. Then, in the early
investor. It was the mid-80s 2000s, we shut that program
C.T. Fitzpatrick (CTF): I and Wall Street was booming. I down because basically we
was a weird kid. I was reading had some opportunities on the rode cap rates down from 12%
the Wall Street Journal when I money management side, but I to 8% and thought the bargains
was 14 years old. My father also had an opportunity to had dried up. Obviously we got
was my mentor. He was an work here in New York in out too early. I became a
entrepreneur and I was just investment banking. generalist again. At that point,
curious about what he was we had moved into
doing. It became an intellectual G&D: What was that job? international and global. That
curiosity. My dad was a value was really fun.
investor but he didn’t know it. CTF: I worked at Merrill
He didn’t call himself a value Lynch capital markets. I met Then, in early 2007, I decided
investor. He did a lot of things my wife. She was a trader at it was time for me to move on.
in real estate and he would try what now is Credit Suisse First I’d been there for 17 years. I
to buy properties at a discount Boston, which was First think anyone who’s passionate
to replacement value. He’d be Boston at the time. It was a about what they do, and
looking for things that had fat great experience but I was only strives to continuously
cap rates, things like that. on the edge of what I wanted improve, will keep their core
to do. I was an agent, not a principles but continue to
Since I knew I wanted to go principal. refine them over time. I began
into business, I did not have to feel very strongly about
the patience to pursue liberal I went back to graduate school some things that I wanted to
arts, so I went straight into at Vanderbilt’s Owen School of do in my own personal
corporate finance at the Management and had a great evolution.
University of Alabama. I experience there. It was a lot
(Continued on page 28)
Page 28
Highbridge Capital to get coffee for the team—my these days. But, at the time,
Management, where he first opportunity to showcase there were more
managed the firm’s Asia my work was an FX arbitrage opportunities than there was
investment portfolio. Prior opportunity in Venezuela. It hedge fund capital in places like
to joining Highbridge in was an onshore-offshore arb Italy.
January 1995, Mr. Fischer of converting ADRs.
served in the Israel And then we got involved in
Defense Forces. Mr. Highbridge co-founder Henry the Japanese convertible bond
Fischer graduated from Swieca ’83 was extraordinarily market. That was then the
Yeshiva University, New generous towards me. I was largest CB market in the
York, in 1993 with a working with Alex Jackson ’91 world, because Japanese
Seth Fischer Bachelor of Arts in at the time—and he suggested companies were issuing so
Political Science. He is a I present the Venezuela idea to much CB paper. And this
Board Member of the Henry. I did, and Henry said, reflected a regulatory quirk of
Karen Leung Foundation, a “Great. Here’s half a million Japan. Insurance companies,
Board Member of Carmel dollars, why don’t you give it a who were among the biggest
School in Hong Kong, and try?” allocators of capital, had limits
Vice Chairman of the Ohel on how much equity in other
Leah Synagogue That was still a lot of money corporations they could own.
Management Committee back then, but we gave it a try So corporations would issue
in Hong Kong. and it worked. I stopped what are essentially surrogate
getting coffee and started bonds as equity–securities that
Oasis manages a looking for more stood in the eyes of the
combination of strategies opportunities. We then did regulators as bonds but that
that focus on investing, some cash extraction trades in offered equity-like
trading, and arbitrage Italy, where interest rates participation. And they issued
across global capital were really high. them cheap. There was just so
markets with an emphasis much supply of paper that it
on Asia, taking an G&D: What’s a cash was shockingly cheap.
opportunistic approach in extraction trade?
multiple strategies and Then I started getting involved
asset classes. It invests in SF: This may seem alien to with everything else. There
long and short current MBA students, but was a wide variety of arbitrage
opportunities across once upon a time the world opportunities in Malaysia,
markets and capital had both high interest rates Indonesia, and the Asian
structures, and and opportunities for pure Tigers. Soon, the 1997-98
investments are selected arbitrage. And cash extraction Asian crisis occurred, and I
for their optimal risk- is literally buying a warrant, learned about risk
adjusted return profiles. shorting the underlying stock management and how to deal
The firm’s investment and receiving interest on your with problems quickly.
approach combines short sale proceeds. At the
fundamental value analysis time, rates in Italy were about G&D: You started off in the
with sensitivity to changing 12%, so high that you could business finding arb
market environments. actually make money for free. opportunities, but Oasis is a
lot more than arbitrage today.
Graham & Doddsville G&D: And this would be very How would you characterize
(G&D): How did you get your hard to do in today’s near-zero Oasis’s strategies?
start in investing? environment?
SF: As I say to my traders,
Seth Fischer (SF): My first SF: Yes, this is impossible to and to my investors, “We’re
professional job in finance was do at zero. Plus, the world is trying to make a buck, and not
at Highbridge. Besides getting much more efficient and lose one.” And we have three
coffee for the traders on the there’s much more capital, so idea buckets: We are trying to
team —and, in fact, when I this opportunity would be do it faster than everyone else,
started out, I was running out arbitraged away in 30 seconds know it better than everyone
(Continued on page 36)
Page 36
Contact Us:
[email protected] Graham & Doddsville Editors 2017-2018
[email protected]
[email protected] Abheek Bhattacharya ’18