Friday, February 29, 2008

Dean Foods’ New Slogan: “It Seemed Like a Good Idea at the Time”

The poster child of the perils of following Wall Street’s whims must certainly be Dean Foods, the low-margin Dallas-based dairy company that almost one year ago to this day proudly “returned value to shareholders” through a special one-time, $2 billion dividend, just before commodity inflation was to rip the guts out of Dean Foods’ cost structure.

Its share price was north of $45 at the time.

Last night the same company did a spot secondary of 18.7 million shares in order to help pay the debt incurred in funding that special dividend, at a price just south of $20 a share.

Most galling to shareholders must certainly be that last night's sale price is just a few bucks more than the $15 a share special dividend that destroyed the commodity processor’s financial flexibility to begin with.

For those who would defend the investment bankers who came up with the goofy scheme of loading a commodity processor with debt just for the heck of it—not to mention the fees—and the Board of Directors that approved the goofy scheme mainly to feel good about themselves for a few months, we say study the history of Dean Foods’ primary cost inputs and ask yourself if a low-margin, highly volatile business model justified anything more than a modest, regular dividend to patient shareholders.

Rather than re-hash the gory circumstances surrounding this travesty of corporate chest-thumping, investment banker hubris and short-term herd-following, we republish for the record accounts of both actions, on the theory that those who know their history may be less inclined to repeat it.

March 2, 2007

Dean Foods Announces Plan to Return Approximately $2.0 Billion to Shareholders Through Special Cash Dividend of $15.00 Per Share

Reflects Strong Confidence in Business and Future Cash Flows; Commitment to Enhancing Shareholder Value Financed By $4.8 Billion Senior Secured Credit Facility

DALLAS, March 2, 2007 /PRNewswire-FirstCall via COMTEX News Network/ -- Dean Foods Company (NYSE: DF) today announced plans to return $15.00 per share to shareholders through a one-time special cash dividend totaling approximately $2 billion. The special dividend will be financed by a recapitalization of the Company's balance sheet through $4.8 billion in new senior secured credit facilities.

"Dean Foods is an organization with strong momentum as reflected in our 2006 results and positive outlook for 2007," said Gregg Engles, Chairman and Chief Executive Officer. "Over the past several years we've consolidated the industry and developed a leading market position through significant strategic acquisitions and investments in building out our branded portfolio. With this platform in place, we are now entering the next phase of our evolution. Over the next few years, we will be focused primarily on leveraging our scale to drive internal growth through maximizing productivity and efficiencies across our business."

Engles continued, "Given our internal focus, our strong cash flows, and the incredible liquidity and flexibility of today's debt capital markets, the appropriate finance decision for Dean Foods today is to increase our exposure to the debt markets and return equity capital to shareholders, while enabling them to continue to participate in the Company's future performance and growth."

February 29, 2008

Dean Foods to issue 19 million shares

Dallas company hopes to make progress on debt repayment

10:44 PM CST on Thursday, February 28, 2008
By KAREN ROBINSON-JACOBS / The Dallas Morning News

Dallas-based Dean Foods Co. said Thursday it will issue 18.7 million shares of stock, in part to pay debt from a dividend it gave shareholders last year.

The new stock offering, being underwritten by Lehman Brothers, will help bring the nation's largest dairy producer closer to the debt repayment schedule it planned on when it issued the dividend last spring, the company said in a filing with the Securities and Exchange Commission.

"The operating environment in 2007 was extremely difficult, and operating results were below the expectations" Dean had when it issued the dividend, the company said in the SEC filing.
"As a result, the company entered 2008 approximately a year behind its original debt reduction expectations."

"Momentum," as Engles found out the hard way, changes frequently.

Debt, of course, never does.

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Tuesday, February 26, 2008

Been to a Dairy Queen Lately? Concluded.

“Dairy Queen is a business that I like, run by an outstanding management team. Dairy Queen will be a great addition to the Berkshire family.”

—Warren Buffett, October 21, 1997

“Too many of our restaurants are simply not competitive…. Our name has been tarnished and aged because we have a system that is relatively inconsistent, lacking commitment and investment, and lacking enthusiasm and excitement.”

—Dairy Queen CEO Chuck Mooty in Restaurant Business, September 1, 2001

So which is it?

Is Dairy Queen “A great addition to the Berkshire family”? Or “Not competitive…tarnished and aged?”

By any standard, International Dairy Queen—the company’s official name—should have been the “great addition” promised by Warren Buffett, neatly fitting as it does his definition of a good business.

First and foremost, Dairy Queen possesses one of the most recognized brand names in America. This alone has kept customers coming through its doors or walking up to its stainless steel counters—“tarnished and aged” though they might seem, even to the company’s own CEO—for sixty seven years, and counting.

Good too is the fact that its signature product—soft ice cream—is not a luxury item, a fad, or prone to technological obsolescence. Consequently, sales tend to be steady in good times and bad.

And that strong brand name has one more benefit: it means Dairy Queen can raise prices in times of inflation, when a less well-known outfit might not have the clout—an attribute Warren Buffett especially admires, and seeks in the companies he acquires.

Digging deeper into the Dairy Queen business model, what at first appears to be a huge drawback—the fact that its stores offer a more limited menu compared to some competitors (many Dairy Queens do not even sell food)—turns out to be no great drawback at all. While the typical “DQ” generates only about one-third the revenue of a typical McDonald’s, the ‘footprint’ of a typical DQ unit is likewise smaller, and therefore cheaper to build and operate, than the typical McDonald’s.

Furthermore, another apparent disadvantage—that Dairy Queen has not always kept pace with changing American eating habits as aggressively as other “quick serve” restaurants—does not necessarily make it a less attractive business.

It may be true that Dairy Queen’s last major hit new product was “The Blizzard” ice cream treat, officially introduced more than twenty years ago. And the company’s ballyhooed 2005 introduction of the “GrillBurger” did not exactly set the world on fire, a “GrillBurger” being—brace yourself, now—a quarter-pound hamburger, with fixings.

McDonald’s—which introduced its quarter-pounder in 1973—expanded beyond burgers, fries and shakes early in its development and continued evolving, most notably through the introduction several years back of healthier salads with Paul Newman’s dressing, and this year’s nation-wide roll-out of espresso drinks in direct competition with Starbucks.

Still, all these new products cost money, thanks to the necessary equipment upgrades and labor training involved—costs borne largely by McDonald’s store operators. If the 2005 quarter-pound “GrillBurger” is any indication, Dairy Queen store operators have little to worry about when it comes to shelling out money for new equipment upgrades or better-trained in-store labor.

All in all, International Dairy Queen has a great brand name, a steadily growing business, pricing power in its major product line, little risk of obsolescence, and a low cost of operation.

What could be better?

Perhaps only this: if the company didn’t have to perform the down-and-dirty duties of actually owning and running the stores, but instead made its money by collecting license fees for the brand name from territory operators and franchisees and by selling Dairy Queen ice cream and paper products to the store operators at decent mark-ups.

And that is precisely how International Dairy Queen is structured.

Consequently, it is the men and women who own and operate the stores—and not the parent company owned by Berkshire Hathaway—who deal with the day-to-day aggravation of upkeep, scheduling, broken equipment, employee turnover, bad weather, utilities, employee theft and vandalism—not to mention the occasional insurance claim for whatever happened in the parking lot over the winter when the place wasn’t even opened.

Now, this is not to say that Dairy Queen territory owners and store franchisees haven’t done quite well for themselves.

They do, after all, reap the same benefits of a great brand name, steady business and pricing power as the parent company. In fact, estimates of the typical Dairy Queen store owner’s income have put the figure at roughly 15% of sales, about the same as the parent company. Furthermore, many operators now own their land and buildings free and clear, having long since paid off the mortgage.

Still, the next time you drive by a tired-looking, weather-beaten Dairy Queen down the road from a sprightly-looking McDonalds, or Dunkin’ Donuts, or even Starbucks, and you scratch your head wondering who’d want to own International Dairy Queen what with all those competitors serving cold treats to the parents and kids who used to go to the local “DQ,” keep in mind the owner of that Dairy Queen is likely buying supplies from, and paying license fees to, Warren Buffett’s company, year in, year out.

And that’s a good business.

All this does not, however, automatically mean Dairy Queen has been “a great addition to the Berkshire family,” as Buffett predicted in 1997.

First—as we saw while working through some rough calculations earlier—by paying for the company partly in shares of Berkshire Hathaway stock, Warren Buffett may well have reduced what could have been a spectacular return on his investment to something more ho-hum.

Furthermore, as International Dairy Queen’s own CEO has plainly admitted—and as anyone who has in fact been to a Dairy Queen lately may have experienced—the company’s store network does not necessarily measure up to the kind of standards normally associated with a “great” business.

Finally, when Buffett agreed to buy International Dairy Queen, he agreed to buy a company with not just a well-known brand and a steady business selling cups and ice cream to franchisees.

He agreed to buy a company with a lawsuit. And a class-action lawsuit, at that.

Filed in 1994 by six franchisees seeking to buy some supplies outside the Dairy Queen “system,” the suit charged International Dairy Queen with violations of the Sherman Anti-Trust Act. By the time the company had become a wholly owned subsidiary of Berkshire Hathaway, the suit had gained class-action status, reportedly involving about a third of the Dairy Queen franchisees.

Lawsuits in corporate America are, of course, commonplace, and investors don’t often see them rise above the general category of a nuisance. This one did, however, and in 2000 the company settled it (while denying any wrongdoing) for millions of dollars. Fifty million of them, in fact, according to published reports, including a six-year, $5 million a year commitment to a national advertising fund.

Details of the precise financial impact on International Dairy Queen’s income may never be known given the company’s small impact on Berkshire as a whole. But $5 million a year in extra advertising spend would have been the equivalent of nearly 10% of the company’s pre-tax income the year before Berkshire acquired it—assuming insurance did not cover the costs.

And the fallout from the lawsuit went beyond the financial kind, pitting as it did the company against the very franchisees upon which the health of the “Dairy Queen system” depended. CEO Mooty described the aftermath this way in an interview in QSR Magazine, 2001:

“We are a fragmented system in many respects, and we’ve gone through a real battle with a group of our franchisees in a litigation that took over eight years, and that creates erosion, fragmentation.”

He wasn't kidding.

Today there are Dairy Queens that sell food (usually under the mysterious “Brazier” logo), and there are Dairy Queens that sell only ice cream. Dairy Queen stores in warm markets are open year-round; hundreds of stores in northern states are closed for winter. Some Dairy Queen units are painted red, white and blue; some aren’t.

The parent company—Buffet’s company—doesn’t even set the retail price of its products: store operators have that power. And royalty rates to the parent are said to vary widely: in fact, some stores aren’t even obliged to pay any franchise fee at all.

I am not making that up.

All of which may help explain why Dairy Queen’s growth has lagged its competitors for so many years, both before and after it became a part of “the Berkshire family.”

McDonald’s, which did not start franchising until 1955 (when Dairy Queen already had 2,600 units opened in North America), now has more than 30,000 restaurants around world, five-times the current Dairy Queen total.

And if comparing the growth of a chain selling something as prosiac and discretionary as ice-cream to that of a hamburger chain such as McDonald’s seems unfair, then let’s compare it to a chain specializing in something equally prosaic and discretionary.

Let’s compare it to a chain of stores selling coffee.

This particular coffee chain did not exist prior to 1972, did not bother to expand outside its home market of Seattle, Washington until after 1987, and did not even go public until 1992. Yet it currently has over 11,000 stores in the U.S. and more than 4,500 internationally, generating over $9 billion in annual revenue with operating margins comparable to that of International Dairy Queen.

The coffee chain, of course, is Starbucks. And, current growing-pains aside, Starbucks shows what an aggressive, forward-thinking management team can do when it's willing to spend the dough to make growth happen.

But it's not just by comparison with hamburgers and coffee that Dairy Queen's growth seems paltry. Even the vendor of such a uniquely American specialty as fried chicken has grown faster and further around the world than Dairy Queen and its soft-serve ice cream.

Kentucky Fried Chicken—now known as KFC and part of the fast-food portfolio of Yum! Brands (yes! the exclamation point is part of the name!)—began franchising in 1952 and now has over 14,000 units around the world. In fact, there are more KFCs outside the U.S. than inside, and 2,000 in China alone.

Dairy Queen, meanwhile, recently opened its 100th store in China.

So, has Dairy Queen really been a “great addition to the Berkshire family”?

Warren Buffett would certainly say it has, given the excess cash flow generated by its steady, slow-growing business model. After all, Warren Buffett loves nothing in the world so much, perhaps, as cash flow he can invest wherever he sees fit.

And who wants to argue with Warren Buffett?

But let’s flip the question around and ask ourselves if Berkshire Hathaway has been a great home for International Dairy Queen.

To do this, we return to the original premise of John Mooty, the Dairy Queen Chairman at the time of the sale, who wrote the following in a letter to shareholders explaining the Board’s decision to sell to Berkshire Hathaway:

“In considering this merger, we took into consideration the best interest of the entire Dairy Queen system, consisting of our employees, our franchisees, our territory operators, our suppliers, our customers and our shareholders.”

As far as Dairy Queen employees go, at least one such employee—Mr. Mooty’s son Chuck, who was Chief Financial Officer at the time and now runs the place—must certainly be glad the company wasn’t sold to a less hands-off manager than Warren Buffett.

As for the Dairy Queen franchisees and territory operators, however, a few appear no happier as part of the Berkshire “family” than before. In 2006, just six years after the class-action suit was settled, the Dairy Queen Operators Association filed suit in Illinois “claiming the company is trying to force its mom-and-pop restaurant-owners out of business,” according to the Minneapolis/St. Paul Business Journal.

Regarding Dairy Queen's suppliers, it’s anybody’s guess how they're feeling about being part of the “family,” although some might wish they’d hitched their wagons to a more ambitious organization growing faster than what looks like a rather paltry one-quarter-of-one-percent annual unit growth rate.

And here we come to the end of Mr. Mooty's list: the shareholders of International Dairy Queen, including those who vocally complained about Buffett's seeming low-ball offer. Today those former shareholders are, most likely, of two minds about the 1998 transaction that transferred ownership to Berkshire Hathaway.

Shareholders who followed John Mooty’s own strong convictions and accepted $26 in Berkshire Hathaway stock—and watched it triple to a current value around $75 in the decade since—probably agree that Berkshire Hathaway has indeed been a “great family” to have joined.

Those who elected to take $27 per share worth of cash instead of Berkshire Hathaway stock, however, might still be ruing the day they went for the extra dollar, thereby missing out on another $48 for each of their shares that accrued over the years.

Of course, these individuals could certainly console themselves with the knowledge that since Berkshire’s acquisition, Dairy Queen has remained, on the surface at least, a sleepy, slow-growing entity left behind by its peers in parts of America and much of the quickly-developing world.

Still, they probably skip reading the stock tables starting with the letter “B.”

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. Readers who make investment decisions based on this material are making a mistake. This commentary in no way constitutes investment advice, nor is it intended to be a solicitation of business in any way. It is intended solely for the entertainment of the reader, and the author.

Sunday, February 24, 2008

Weekend Edition: Wisdom of Solomon?

Easily the most-read section of the New York Times Sunday Magazine, besides the crossword puzzle, is the “Questions For…” column by Deborah Solomon.

I say this without a single statistic to validate the claim, but it’s the only thing I read every weekend in the Magazine. For some reason it just seems to pop out as you open the thing up.

Besides, who wants to read the cover story about Mike Huckabee or whoever the politician-of-the-week happens to be? You can read Solomon’s column, feel like you’ve read the Magazine, put it in the recycle bin and move on with your day.

Solomon herself comes across as witty and direct, with an extra-liberal agenda. Not that there’s anything wrong with that—it just seems that every series of questions, whoever the person being interviewed, ends up with her insinuating how great it would be if Hillary became President.

The page is usually interesting, funny and sharp.

Not so was a recent “Times in the Air”—a New York Times television ‘magazine’ appearing on JetBlue TV sets in planes across the country—featuring an interview with comic Steve Martin.

Martin recently published a book about his stand-up comedy career, and for anybody interested in the process of creativity—how people create stuff, whether it’s great literature, great software, great companies or just great standup comedy—the book is fascinating.

So I watched the Steve Martin interview with some anticipation and much interest.

What I didn’t anticipate, however, turned out to be the most interesting part of the interview, aside from Martin’s stories of his early career: how poor the interviewer from the New York Times would prove to be.

She seemed particularly interested in taking the interview in a certain direction, regardless of what Martin was actually talking about. So interested was the interviewer in getting to a particular subject that while Martin was making a very funny point about how undeveloped he had been as a young comedy writer for the Smothers Brothers, she actually began skimming through Martin's book, head bent, nodding and saying “uh-huh” while Martin spoke.

He noticed she wasn't looking at him, so he turned to the audience and finished his story. When the audience began laughing, the interviewer gave a half-hearted, pro-forma chuckle and then proudly said “I found the paragraph I was looking for,” and promptly asked her own, entirely different, question.

But the worst was yet to come.

Asked why he stopped doing stand-up abruptly, rather than gradually, Martin explained that stand-up is something you have to do constantly, “300 nights a year,” to stay sharp. To stress the point, he said he always worked the night before a “Tonight Show” appearance, because if he didn’t do that, he wouldn't be at his best with Johnny Carson.

To this, the interviewer asked the whopper that stopped her subject cold: “You can’t practice at home?”

Now, Steve Martin, to his credit, didn’t burst out laughing or make a remark—although you could see he held himself back. Instead, he smiled and politely said no, you need an audience.

The interviewer, I learned as the credits rolled, was—as you might have guessed by now—Deborah Solomon.

But I didn’t make the connection until this week’s “Questions for Gov. Rick Perry: Troop Leader” in the Sunday Magazine.

In it, Solomon focuses on Perry’s involvement in the Boy Scouts, pressing him on the issue of gays in the Boy Scouts, which apparently is a huge issue among, well, gays and the Boy Scouts.

Having never been involved in the organization, we here at NotMakingThisUp take no sides, our interest being in Solomon's habit of moving the interview into a narrow area of her own special interest.

And here, after taking Perry to task that “the Scouts are alienating so many American kids,” Solomon hones in on what really seems to bother her: Boy Scout merit badges.

She asks, and I am not making this up:

I know they have a dog-care merit badge, but why not a child-care badge?

When Perry says he has “no problem with that,” Solomon bores in harder with this line of inquiry, which, again, I am not making up:

How about a merit badge in vegetarianism?

To Perry’s credit, he—like Steve Martin on the “Times in the Air” interview—avoids the easy, sarcastic come-back.

Like, oh, “How about a merit badge on interviewing people competently?”

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Thursday, February 21, 2008

Roof Sold, and a Hard Rain Is Falling

Yesterday, the credit crisis hit two national retailers: San Francisco-based Sharper Image, which sells high-tech gadgets such as air purifiers and massage chairs, and Lillian Vernon Corp., which sells low-cost gifts such as Easter baskets and welcome mats. Both filed for federal Chapter 11 bankruptcy protection.

—The Wall Street Journal

And so The Sharper Image yesterday declared what it had been rumored for months to be preparing: Chapter 11.

What goes around, as they say, comes around, and in this case, what went around at Sharper Image was a hubris during its salad days when everybody in America plus their cat seemed to need a tall, thin, plastic air filter supplied by Sharper Image.

Back then—only three or four short years ago—the company, which attracted short-sellers the way a cat attracts fleas, actually had a slide in its investor presentation showing the short interest in the stock, which the CFO at the time would cheerfully discuss at length.

The implication being, of course, that Sharper Image shares—despite having begun to suffer from missed earnings and a growing glut of air filters in the market—could be squeezed not by management skill at turning around the business, but by forced short-covering.

Air filter market gone, sales collapsing and the short-bashing CFO long gone, even a new management team, brought in by financial backers who forced out the old CEO and bought his 2.7 million shares of near-worthless stock for $9.25 a share, could not stop the bleeding.

And so today we read that the company’s bank—Wells Fargo—failed to place the last $10 million of financing necessary to avert a bankruptcy filing, and pulled the plug.

The synchronicity here is quite something, for back in 2005 Sharper Image spent roughly $10 million to repurchase its own stock, no doubt to “return value to shareholders,” as the mantra-of-the-month went during the financial salad days of yesteryear, not to mention “squeeze the shorts.”

Yesterday that $10 million could have come in handy.

What other “return-value-to-shareholder,” short-squeezing boards of directors are going to wish they hadn’t sold the roof during the sunny days...just in time for the rain to start falling?

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. No reader of this material should make any investment decisions based on this commentary. Furthermore, these writings in no way constitute a solicitation of business or investment advice. They are intended solely for the entertainment of the reader, and the author.

Saturday, February 16, 2008

Hillary's Campaign In Trouble? Introducing CLINTONS

Big Clinton Fund-Raisers May Run Their Own Ads
Rich Backers Huddle With Lawyers to Help Cash-Strapped Effort

WASHINGTON -- As Sen. Hillary Clinton faces a money crunch, several of her top fund-raisers are considering using independent organizations to wage their own campaigns on her behalf.
—The Wall Street Journal

Days after the revelation that Hillary Clinton’s Presidential campaign had borrowed $5 million from the candidate’s own fat bank account to make ends meet comes this word the Clinton campaign is so hard up for cash it’s trying to figure out a way to farm out fund-raising to other entities, without violating pesky campaign laws.

The fact that Senator Clinton’s campaign is in crisis is fairly clear to everybody...everybody except the front page editors of the New York Times. The Times, of course, endorsed Clinton when she appeared invincible, which may be why the paper relegates every new report of either an Obama primary victory or a Clinton super-delegate desertion to thin, single-column articles with the muted headlines normally used for cricket matches.

But the diminishing power of the Times' withering old-economy muscle can't seem to stop Obama, and the Clinton team, which has blown through more than $100 million with fewer delegates than Obama to show for it—at an average cost of about $100,000 per delegate—needs cash.

So much so that the self-styled "middle class" candidate is loaning millions of her own wealth just to keep the lights turned on, and her staff is hatching some rather far-out schemes to enable her to stay in the race.

In the spirit of this President's Day Weekend, may we here at NotMakingThisUp suggest another way?

A way that might not only jump-start the troubled Clinton campaign, but also the troubled American economy;

A way that would give hope not just to legions of Hillary fans across the country desperate to see their candidate recover her lead, but to legions of once-highly-paid mortgage-backed securities bankers desperate to find ways to pay the lease on their personal G-5s;

A way that could provide not just enough adrenalin to help the Clinton campaign get back on its feet, but help today’s skittish mortgage-backed credit market get back on its feet.

How, you ask?

Mortgage the White House.

That’s right: we here at NotMakingThisUp officially urge Congress to allow those Titans of Leverage—the mortgage-backed securities bankers who once used their computers to find new ways for status-hungry Americans to satisfy short-term urgings for better cars, bigger plasma TV sets and bathrooms the size of department stores through long-term debt—to help the Clinton campaign borrow all the money it needs against a house Hillary and Bubba don’t yet own, but just might in a year's time: The White House.

And why not?

White House occupants have been monetizing the place for decades by doling out goodies to large donors—sleepovers in the Lincoln bedroom during the last Clinton administration being one of the less subtle examples.

So just make it official. Let Wall Street’s Best and Brightest help the Clintons the way they helped so many Americans during the housing bubble, consequences be damned!

Precisely how is a point we leave to sharper minds with faster computers, but in the fine tradition of CDOs, CMBSs, HELOCs, RMBSs, REMICs and other financial instruments Wall Street excels at inventing without regards to the human consequences, we suggest the following: “Collateralized Election Obligations.”

Or, in short, “CLINTONS.”

Simply mortgage the White House, room by room, from the Lincoln Bedroom all the way down to the White House Theater and the below-ground hidden bunker. Test the markets with a $100 million face value initial offering and see how it goes. Expand or shrink the deal depending on market demand.
Like any complex debt instrument, our proposed CLINTONS could be sliced and diced into various tranches—room by room—allowing buyers to satisfy their own particular personal goals (financial or otherwise, if you get the idea).

Best of all, with the backing of all those rooms in America’s most famous house, occupied by America's most powerful woman and Washington's most fun-loving husband, we’d expect CLINTONS will be rated enthusiastically by the rating agencies.
After all, isn’t everything?

Here then is a brief summary of the prospectus we came up with after, oh, five minutes’ worth of analysis:

Security: CoLlateralized electIoN obligaTiONS (CLINTONS)

Face Value: $100 million (can be increased by adding rooms)

Oval Office Tranche: $25 million
Sit in the chair! Get that famous White House operator to track down your friends and invite 'em over!
Or watch Bubba do his famous Bush impersonation, calling Beijing on the Red Phone with a Texas accent and asking for tickets to “those Olympics games ya’ll are having in Taiwan next summer”!

Moody’s: AAA++

Situation Room Tranche: $25 million
The world at your fingertips! Hidden microphones and secret cameras in places you never even heard of before! Help Bubba keep an eye on his latest “situations.”
Especially the Swedish one, if you get our drift.

S&P: Two thumbs up!

Lincoln Bed Room Tranche: $20 million
Bubba and Hillary plan to invite David Geffen back for the weekend, to patch things up...then make the little rat spend the night on the couch in Hillary's room.
Meanwhile, you and Bubba will distract the Secret Service agents from helping the poor guy when the cries for mercy begin!

Moody’s: AAA++

The Presidential Emergency Operations Center: $20 million
Legendary bunker hidden under the East Wing, at your disposal!
You and Bubba scramble some jets and send 'em over Moscow...then order up a posse of smart-missiles to look a little deeper into Putin’s soul than Bush got, if you know what we're saying.

S&P: Two Thumbs Up!

Cabinet Room Tranche: $5 million
Big table, lots of chairs! By day, you'll witness Hillary conduct long, serious meetings about health care and stuff. Yawn!
By night, you, Bubba and his pals will order up some KFC and Jack, then get ready for the biggest No-Limit Texas Hold-Em game in town! Boo-ya!
Later, it's back to the Situation Room to check in on Bubba's Swedish, uh, “situation.”

Moody’s: AAA++

White House Movie Theater Tranche: $5 million
Bubba’s personal video collection, ready to roll!
Did somebody say “‘American Pie’ Weekend Marathon”???


Jeff Matthews
I Am Actually Making This Up

© 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Tuesday, February 12, 2008

Most Interesting Sentence in a Press Release Today

Thus far—and the day is still young—the most interesting sentence in a press release might well be the following:

“In the fourth quarter of 2007, the Company also experienced a softening of demand for certain of its International products due to declining European economies.”

The company is Masco Corporation, maker of all things faucet, cabinet and plumbing related, and therefore one of the larger corporate victims of the sub-prime collapse.

Given that international revenues account for a modest 20% or so of Masco’s sales, the highlighting of European demand issues in today’s disappointing earnings release is somewhat of a surprise. Today's conference call should be quite interesting.


Not bloody likely.

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Friday, February 08, 2008

Business Gets It. When Will Politicians?

Staples Cuts Off Paper Supplier

February 8, 2008; Page A4

Office-supplies retailer Staples Inc. has severed all contracts with Singapore-based Asia Pulp & Paper Co. Ltd., one of the world's largest paper companies, in a move that shows concerns over forest destruction and global warming are having an impact on big U.S. paper buyers.

Until recently, Staples sourced about 9% of its total paper supply from APP and used the paper for its own Staples-branded stock, mainly photocopy and office paper. Staples had stuck with the company even as other large paper sellers in the U.S., Europe and Asia, including Office Depot Inc., stopped buying from APP in recent years because of alleged environmental misdeeds.

The Framingham, Mass., company canceled its contracts late last month, said Mark Buckley, vice president for environmental issues at Staples. Staples is expected to announce the move next week.

"We decided engagement was not possible anymore," Mr. Buckley said. "We haven't seen any indication that APP has been making any positive strides" to protect the environment. Remaining a customer of APP was "at great peril to our brand," he added.

—The Wall Street Journal

As long-time readers know, it is the official policy of NotMakingThisUp that global warming is no mere figment of the imagination of “pot-smoking journalists,” as Warren Buffett’s partner, Charlie Munger, ventured during last year’s otherwise pleasant and enlightening Berkshire Hathaway annual meeting, in what was one of several Grumpy-Old-Man pronouncements that served more to highlight Munger’s age than his famous wit.

Yet, as today's article demonstates, the ranks of skeptics—several of whom will, no doubt, post caustic rebuttals as soon as this hits their screens—ascribing the horrendous and staggering climate change that has occurred since the advent of the internal combustion engine to random temperature fluctuations comparable to past warming patterns, is growing thinner.

GE—to name but one of many large capitalist enterprises that could very well run its business without the least nod to global warming, but don't—sees both the writing on the wall and the business opportunity inherent in the problem of slowing, if not reversing, the change.

Of course, companies like GE and Staples don’t do stuff just because “pot-smoking journalists” write alarmist stories about something. Consider how long it took for GE to settle on a Hudson River cleanup of the 1.3 million pounds of PCBs GE's plants dumped in its waters.

And since NotMakingThisUp normally prefers to tweak captains of industry than praise them, we thought it worth highlighting Staples’ move, as reported in today’s Wall Street Journal, cutting off Asia Pulp & Paper as a supplier of paper stock.

Knowing, as we do, something of APP’s past—an old friend used to buy paper from APP, and said exactly the same thing companies like Staples are saying—we are not at all surprised at the link being made between Indonesia’s rapidly depleting rain forest and APP’s rapidly growing topline in the last two decades.

At the risk of stretching “fair use” standards to include the entire Wall Street Journal story—we always urge everyone read the Wall Street Journal cover-to-cover every day, and not just for the business stories—we continue with the rest of today’s article.

APP representatives didn't return calls seeking comment. In the past, it has said it is moving toward relying for all of its wood on plantation trees but needs to cut natural forest to maintain production levels.

APP runs one of Asia's largest pulp mills on the Indonesian island of Sumatra and has operations in China. The retailers worry that APP is destroying natural rainforest to feed its mills.

Concerns over rainforest destruction have been heightened in recent months because new data show that Indonesia is the world's third-largest emitter of carbon dioxide, the heat-trapping greenhouse gas, behind the U.S. and China. Fires set to clear natural forests and forested peat swamps after they have been logged are the major cause of those emissions.

APP last year sought permission to use an environmentally friendly logo issued by the Forest Stewardship Council. In October, after inquiries from The Wall Street Journal about APP's planned use of the logo, the FSC barred the company from using it.

Write to Tom Wright at

Next time NotMakingThisUp needs new copy paper, we’ll be going to Staples.

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Wednesday, February 06, 2008

Serge Already Knew What the ISM Just Figured Out

Once again, Wall Street’s economists have finally—thanks to an economics statistic painstakingly compiled and reported by an upright and earnest institution (in this case the Institute for Supply Management, or IMS)—learned something the rest of America pretty much already knew.

This time, it was the following startling fact: the U.S. economy is quite weak.

At least that’s what yesterday’s ISM number—a measure of non-manufacturing business activity—revealed to shocked number crunchers on Wall Street, hitting its lowest level since 2003.

And while the number dropped jaws on Wall Street, I doubt it surprised too many people on the main street where I live.

For on that main street is a small family restaurant—highly successful over many years and many business cycles. And in that restaurant is a busboy named Sergio—one of the hardest working guys I know. And just last week Serge was gesturing at a room full of empty tables and telling me he was worried about his job.

“If it stays like this…” he said, “I don’t know what I’m going to do.” Serge is not a complainer. In fact, I’ve never heard him talk about anything but his family, his grandson, and the New York Yankees.

I asked him if it wasn’t just a slow Tuesday night, and he shook his head: “It’s been like this every night.” And the owners are taking measures, cutting hours, cutting staff.

So, precisely why the ISM number was as startling as it appeared to be to so many professionals is not entirely clear.

After all, if they're not eating at family restaurants and noticing empty tables, a few recent earnings reports would have filled them in.

Just last week Starbuck’s reported a 3% decline in customer traffic. A couple days before that, McDonald’s reported no increase in comparable-store U.S. sales.

And if those data points from two of the largest bellwethers of the American service economy hadn’t registered with the Wall Street economist types, you might have thought the previous week’s commentary from the parent company of the ubiquitous Chili’s restaurant chain would have done the trick:

“Add to this [increasing competition] the uncertainty about the economy, a decline in consumer confidence and increased commodity costs, and we are operating in one of the toughest environments in our company history.”

That history, for the record, goes back almost 33 years.

But if Wall Streeters can be shocked by something so easily visible in their own backyards, imagine the chaos sweeping the Fed!

Maybe they should talk to Serge. I've got his cell phone number if Ben wants to call...

Jeff Matthews

I Am Not Making This Up

© 2008 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

Saturday, February 02, 2008

Been to a Dairy Queen Lately? Part III

“In considering this merger, we took into consideration the best interest of the entire Dairy Queen system, consisting of our employees, our franchisees, our territory operators, our suppliers, our customers and our shareholders.”

—John Mooty, Chairman of the Board, International Dairy Queen, October 21, 1997

Thus the Chairman of International Dairy Queen Chairman explained, in a letter to his company’s shareholders, how it was that he and the rest of the Board had decided to sell an American icon to Berkshire Hathaway for approximately $26.50 a share—a price well below what some of those same shareholders considered fair value:

“He [Buffett] should be paying north of $30,” said [Bruce] Sherman... “There are a lot of shareholders unhappy with this deal. It's not that the company is being sold. It's strictly the price.”
—Bloomberg LP, November 6, 1997

In fact, one of those shareholders was so “unhappy” he sued to block the deal, but lost.

Still, nobody can say Mr. Mooty tried to mislead those shareholders or anyone else as to their place in the scheme of things. After all, in the above-quote letter where he enumerates the components of “the entire Dairy Queen system” taken into consideration during the Board’s deliberations, Mr. Mooty lists the shareholders dead last.

Even after “suppliers.”

Consequently, while Mr. Sherman and other shareholders might have disagreed with the end result, they at least ought to have appreciated Mr. Mooty’s straight talk.

Lawsuit and protestations notwithstanding, in the end Warren Buffett paid precisely the price he and the Dairy Queen Board had agreed on: $27a share in cash to those who preferred cash; or $26 in Berkshire Hathaway stock, to those who preferred stock.

No more, no less.

Looking back at Dairy Queen's weak performance prior to the deal, however, an observor might ask why all the beef over a nice pay-day for shareholders of a stock that had bounced anemically between $14 and $21 a share for more than half a decade?

Well, for starters, for a total price tag of $585 million, Buffett picked up roughly $50 million of cash and cash-equivalents already on Dairy Queen's books, meaning his net outlay to acquire the business was only about $535 million.

And $535 million amounted to only 9.2-times Dairy Queen’s annual pre-tax income in 1996, while shares of Dairy Queen’s most visible publicly-traded competitor, McDonald’s, were changing hands at nearly 15-times pre-tax income in the public market.

Of course, some might say the comparison between Dairy Queen and McDonald’s is not entirely fair. McDonald’s, after all, has a reputation for, and track record of, faster growth and greater innovation than the slow-moving Dairy Queen.

However for the first nine months of 1997—Dairy Queen's last year as a public company—its core revenue growth and earnings growth were only modestly lower than McDonald’s.

The numbers are as follows: excluding the impact of a divestiture, Dairy Queen’s sales grew nearly 4%, while operating earnings grew 3%. McDonald’s, meanwhile, reported full year 1997 sales growth of 7% and earnings growth of slightly less than 5%.

Thus the Board of a company with only marginally slower earnings growth than its largest public counterpart accepted a substantially lower valuation from Warren Buffett than Buffett would have had to pay for shares of that counterpart in the open market. And, for that discounted price, which Buffett negotiated directly with the Board of Directors, Berkshire got control of an entire company.

Is it any wonder some Dairy Queen shareholders griped?

Now, an astute observer would certainly argue that the valuation of McDonald’s in the stock market on a given day provids a meaningless yardstick of the true, underlying value of International Dairy Queen in a negotiated transaction between rational human beings.

After all, stock market valuations fluctuate from month to month, week to week, hour to hour, and minute to minute, depending on breaking news, political scandal, plague, war and federal economic policy, not to mention the serotonin levels in the brains of Wall Street traders apt to fly to pieces at the slightest whiff of something as momentous and earth-shattering as the replacement of an adjective in the Federal Reserve’s latest interest rate statement by a slightly different adjective.

Thus a more objective way to look at the sales price of Dairy Queen would be to simply compare it to the cost of money, which is how most rational buyers—Warren Buffett especially—determine valuation.

Let's start with the government's cost of money: in late 1997, the time of the Dairy Queen transaction, the ten-year Treasury note was yielding something in the neighborhood of 6%. A well-heeled AAA-rated buyer like Berkshire Hathaway would, of course, have a somewhat higher borrowing cost than the Federal Government, so we'll assume Berkshire could have borrowed the $535 million needed to acquire Dairy Queen (and its $58 million in pre-tax income) at an 8% interest rate.

8% interest on $535 million would amount to $43 million in annual interest payments. And $43 million in interest payments would be substantially less than Dairy Queen’s $58 million of annual income at the time.

In effect, Warren Buffett would be buying Dairy Queen with Dairy Queen’s own money, much like a leveraged-buyout.. Most galling to "DQ" shareholders, perhaps, is that Buffett would be paying practically no premium for the intangible but presumably substantial value of the Dairy Queen brand name.

Now, these observations are not meant to suggest the Dairy Queen Board did not do its duty.

First, the calculations are our estimates only: not actual numbers.

Second, no information anywhere exists to suggest that any alternative to the Berkshire offer was made to the Dairy Queen Board of Directors.

Third, as evidenced by Mr. Mooty’s letter to shareholders, there clearly was much more to the sale of one of America’s best-known brands than mere money—at least as far as Mr. Mooty and his fellow Dairy Queen Board members were concerned. And well there should be in any business transaction.

Finally, and most importantly, Berkshire did not pay all that $535 million for Dairy Queen in cash.

Rather, as we stated at the beginning, Buffett agreed to pay slightly more than half the purchase price in Berkshire Hathaway stock, the remainder in cash.

And stock, unlike cash, can appreciate over time, meaning Buffett gave the shareholders of Dairy Queen—at least those smart enough to take $26 a share worth of stock rather than $27 a share worth of cash—a chance to participate in the subsequent growth of Berkshire Hathaway.

That growth would prove to be substantial.

Shares of Berkshire Hathaway closed at $47,500 apiece the day the Dairy Queen transaction closed. They are now trading above $130,000 a share. Thus, the entire value of the Dairy Queen transaction has almost doubled, from the original $535 million value (net of DQ's own cash) when Berkshire’s stock was $47,500 a share to nearly $1.1 billion at today’s $130,000 a share price.

Recall Mr. Sherman, the broker whose clients owned 1.7 million shares of Dairy Queen at the time, complaining that the price should have been “north of $30.” In fact, thanks to the near-tripling of Berkshire's stock price, the current value of the deal amounts to well “north of $30,” .

It amounts to almost $50 a share.

Now, what precisely does Dairy Queen add to Berkshire Hathaway’s bottom line, in exchange for that $1.1 billion investment?

This is not an easy question for an outsider to answer.

For financial purposes, at least, International Dairy Queen has all but disappeared inside the $100 billion conglomerate that is Berkshire Hathaway. In fact, it is lumped anonymously into a segment labeled “Other Service,” along with airplane time-sharing company NetJets; pilot training pioneer Flight Safety; kitchenware outfit Pampered Chef; and the Buffalo News.

A kind of negative clue as to Dairy Queen’s current size and profitability can be gleaned from the fact that Dairy Queen does not even get a mention in the “management commentary” segment of Berkshire Hathaway’s public filings. This means “DQ” neither helps nor hurts Berkshire’s quarterly income enough to rise to the level of significance required for such disclosure.

Consequently, the only hint as to whether any dramatic changes in Dairy Queen’s operations or profitability have occurred under Berkshire’s ownership is the statement in Berkshire’s recent filings that Dairy Queen services “about 6,000 stores,” which is up a little more than 200 from the 5,790 units in operation at the time of the acquisition.

And 200 new units on a base of 5,790 amounts to only one-quarter of one percent annual growth over the last ten years.

Assuming no prices increases on top of the low unit growth, Dairy Queen’s current revenues may not much higher than when Berkshire first acquired the business—perhaps $440 million. If margins haven’t changed from the 14.1% last seen in 1996, the business would be generating roughly $62 million a year in pre-tax income.

Is a $62 million annual return on a $1.1 billion transaction up to Berkshire's usual snuff?

Think of Dairy Queen as a bond that Berkshire Hathaway paid $1.1 billion to acquire. Think of the estimated $62 million income as the current “coupon” on that bond. Berkshire Hathaway's yield on its Dairy Queen bond? A mere 5.6%.

5.6% is not much better than a risk-free government bond, and it is far lower than many current investment alternatives.

Of course, all this assumes our calculations are correct, which they are almost certainly not.

For example, Dairy Queen’s revenue growth might have been substantially higher than we guessed if the company had raised prices all this time. So let's assume prices rose 2 1/4 % a year over the last decade—bringing the annual revenue increase to an even 2.5% since the Berkshire acquisition. The current revenue contribution of Dairy Queen would rise to roughly $560 million, and our estimate of pre-tax income to $79 million, a “coupon” of 7.2% on Berkshire’s $1.1 billion outlay.

7.2% is, likewise, hardly eye-popping, and no better than a decent preferred equity available in today’s market.

Why such a low apparent return on one of Buffett's more cherished investments?

Unlike the cash half of the Dairy Queen deal, which is forever fixed, the stock half of the transaction amounted to a currency that could, and did, appreciate over time. In fact it appreciated far more rapidly—approximately 10% annually—than Dairy Queen’s paltry growth (assuming our calculations are within the bounds of reason).

Had Berkshire paid $585 million for Dairy Queen entirely in cash, and extracted the $50 million already in Dairy Queen's coffers immediately, the return on investment would be substantially better, turning that $79 million “coupon” into a handsome 15% yield on a $535 million net investment—double our estimate for the stock-and-cash deal structure.

Perhaps the only comfort to shareholders of Dairy Queen still ruing the day they accepted cash, instead of Berkshire Hathaway stock at $47,500, is the notion that Warren Buffett might, likewise, still be ruing the day he paid with Berkshire stock valued at $47,500, instead of cash.

Of course, if Buffett had not offered his stock to Dairy Queen's shareholders, he might never have clinched the deal, and Dairy Queen Blizzards would not have become a welcome, carb-loading reprieve at the Berkshire annual meeting.

This is because stock-for-stock deals are not considered taxable events, the way cash deals are, and individuals who control companies through stock acquired at negligable cost, such as John Mooty, whose investment in Dairy Queen dated back to 1972 generally much prefer stock deals to cash.

Furthermore, Mr. Mooty clearly enjoyed the prospect of becoming part of the Berkshire family, as opposed to becoming a relatively insignificant subsidiary of, say, McDonald's, or a mere holding in the vast portfolio of a heartless, numbers-obsessed private equity outfit.

Recall his letter to shareholders recommending approval of the transaction:

"Our family will vote our entire 35% of the voting shares of Dairy Queen in favor of the merger and will elect to receive Berkshire Hathaway Common Stock for all the Dairy Queen shares owned by us. We are not interested in trading our Dairy Queen shares for any other securities. I personally consider Berkshire shares to be one to the finest investments that our family could make and we anticipate holding the shares indefinitely."

You can't say he didn't warn 'em.

Having attempted to gauge how well the Dairy Queen deal served Berkshire Hathaway shareholders’ best interests, we will conclude by examining the original premise of the Dairy Queen Board of Directors and consider whether the transaction with Berkshire Hathaway served the best interests of the “entire Dairy Queen system.”

To be concluded…

Jeff Matthews
I Am Not Making This Up

© 2007 NotMakingThisUp, LLC

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes investment advice, nor is it a solicitation of business in any way. It is intended solely for the entertainment of the reader, and the author.