NROM Valuation Update

I wanted to update quickly here on NROM, my pick for 2013 and largest position in my portfolio. It has made the majority of my gains this year– up over 100%, but I think it goes higher from here.

I think the best way to value NROM at this point (given the success in the T&B segment) is to look out a few years, estimate the # of T&B’s, and value the company on a FCF yield basis (which will likely be approximately the dividend yield). This is somewhat of a simplification of course (dta’s wont last forever for example), but I think this is a good way to gauge value in a variety of scenarios.

I see the stock worth:

-$1.22 even if there are zero T&B’s

-$1.78-$2.37 if they simply maintain the 29 signed stores and it takes two years to fully open/ ramp up

-$2.12-$2.83 if they get to 60 T&B’s in two years fully open/ ramped up

-$2.52-$3.35 if they get to 100 T&B’s in four years.

Needless to say, NROM is still my largest position and I am likely not selling anytime soon.



Straight Path Communications Inc. (STRP): Undervalued, Misunderstood Micro-Cap Spinoff

Connor Haley
Current Price: $5.38
Target Price: $9.58

*the write-up below references graphs and pictures which can be found in the full pdf write-up here:


STRP is a highly misunderstood security with a fantastic risk/reward, and a potential “heads I make 5X, tails I breakeven” scenario


STRP, a recent microcap spinoff from IDT Corporation, is one of the most misunderstood securities I have ever seen, and a fantastic risk/reward at current levels. Even using $30 mm (the rejected sale price in 2010) for the spectrum and $12 mm for the value of the patents (the price Howard Jonas was awarded shares in his own company), one reaches a value of $42 million for the EV, indicating the company is approximately fairly valued. I believe that these bearish assumptions will prove quite conservative, and that given the upside in the patents and the spectrum, STRP is truly a “heads I make up to 5X my money, tails I breakeven.” I conservatively value shares at $9.58, 78% upside from the last sale price of $5.38.

Why STRP Is Misunderstood

  1. Microcap Spinoff: STRP is a microcap spinoff. Many IDT investors and indexes are not allowed to hold STRP and have not thoroughly analyzed the company’s prospects.
  2. Unconventional CEO: Even for the investors who are able to hold or buy STRP, the company’s CEO, Davidi Jonas, is the son of IDT’s CEO and a former schoolteacher. Many investors cannot get comfortable with his leadership and background and therefore do not research the company
  3. Complex, off-balance sheet intangible assets derive the entire value of the company: STRP has two assets: ~1/3 of the nation’s wireless spectrum in the 39 GHZ frequency and a collection of patents. Neither has generated meaningful revenue, making it easy for investors to “pass.” Furthermore, the spectrum was written off as worthless in 2009, but began to attract real interest and show its potential value in 2010 and 2012
  4. Poor disclosure and understanding of spectrum value: Even the little buy-side research I have seen has misunderstood how the spectrum should be valued. Furthermore, the company’s recent investor presentation is somewhat misleading on industry estimates for small-cell rollout
  5. Investors failing to properly understand risk/reward: Some investors have considered this a lottery ticket, but in reality, even if STRP is unable to roll-out their spectrum nation-wide, it has significant value even in a piecemeal sale. Furthermore, I believe the companys greatest source of downside protection is actually in the patents.

Business Overview

STRP’s business has two separate segments. First, it owns 100% of Straight Path Spectrum, which owns, licenses, and leases the largest U.S. portfolio of FCC licenses for 39 GHz wireless spectrum covering greater than 90% of the country. In addition, it owns an 84.5% stake in Straight Path IP Group, which holds a portfolio of patents primarily related to communications over the Internet. I will cover the patents first and describe why I think they provide substantial downside protection for the stock before then moving on to address the somewhat more complicated spectrum story.

Patents Overview

The IP Group has the goal of licensing its patents to other companies and suing companies who currently infringe on its patents. In 2010, the IP Group successfully settled a patent infringement case with EBay and Skype on undisclosed terms. In 2012, it successfully settled with Stalker Software, ooVoo, and Vivox for patent infringement. More recently, it has ramped up its patent protection efforts and has partnered with legal powerhouses Kirkland and Ellis and Mintz Levin on a contingency basis (with a maximum payment to them of 40% of proceeds depending on timing). On August 1st, the IP Group filed complaints against Panasonic, Toshiba, Sharp, Sony, LG, and the telecom providers, Telesphere, and Vocalocity. Lastly, on August 26th, the Group filed patent infringement cases against Blackberry, Huawei, Samsung, and ZTE.

Many value investors skip over the patents or give them little attention because they are not patent experts, but this is a huge error because they provide the most downside protection.

Key Patent Considerations

  1. Skype settlement provides key precedent and further legitimacy to patents: The patent claims have already been thoroughly examined and upheld in trial with Skype/Ebay. IDT was not represented on a contingency basis at that point and Skype was very aggressive in trial, but IDT was able to reach a Skype settlement, giving STRP more legitimacy and leverage in the patent process.
  2. The spinoff created a strong corporate structure for patent litigation: Companies that are sued for patent infringement can either 1) challenge the legitimacy of the patent claims or 2) buy other patents and sue the operating company in an attempt to gain negotiation leverage. Skype did both with IDT. With virtually no operating business, STRP cannot realistically be counter-sued, putting it in a much stronger position to sue companies than before. Furthermore, the company filed lawsuits the same day it completed the spinoff, indicating that the company was “ready to go” and also that there was a sense of urgency (likely encouraged by K&E) to get started on the litigation.
  3. Top law firms in the country want to litigate on a contingency basis: The fact that Kirkland & Ellis, one of the top law firms in the country, is willing to litigate on a contingency basis implies a much larger value for the patents than the market is ascribing to them.
  4. Howard Jonas thinks the patents are valuable: In 2012, Howard Jonas, the CEO of IDT Corp, decided to take stock in the patent-holding entity in lieu of cash. He has a history of taking stock in companies he owns before they take off in value, such as in 2008:

How much are these patents worth? While it is difficult to be precise, I think the easiest way to ballpark is to figure out how much Kirkland & Ellis has to think they are worth in order for them to litigate on a pure contingency basis. Top law firms such as Kirkland & Ellis have their pick of cases to litigate on a contingency basis. Top firms also typically turn down over 90% of contingency cases, and the ones they do agree to typically have expected settlements in the $25-$100 million range according to the following source:

After speaking with management and lawyers, I got the sense that K&E was likely seeking something at least in the higher end of that $25-$100 million range and likely more. It also sounded like most of the top law firms wanted this case and that management interviewed all the top law firms and ended up deciding on K&E. Using $25 million as the low case, $100 as the base, and $175 as the high case, the overall value to STRP shareholders is in the $12.7-$88.7 million range. My base case of $50.7 million is more than the entire enterprise value of the company, meaning you get the spectrum assets for free. It should also be noted that Howard Jonas’ 2012 compensation in the patent-holding entity valued the entire entity at $12 million (10% for $1.2 million). This is sort of a sanity check on the low case, but I do not think it is indicative of value given that he was taking compensation in a company he controlled well before all of these lawsuits were filed and before the strategic spinoff.

Patent Valuation Low Base High
Total Proceeds from Lawsuit 25 100 175
Max Value (40%) to K&E 10 40 70
Net Lawsuit proceeds 15 60 105
STRP’s stake 84.50% 84.50% 84.50%
Total Patent Value to STRP 12.7 50.7 88.7

Spectrum Technology Overview

Understanding the Spectrum business requires first a general understanding of how mobile devices connect to the Internet and how STRP fits into this evolving process. The amount of data being transmitted by mobile phones has exploded in recent years, largely due to the rise in the usage of smartphones. As demand for data usage continues to grow, Internet providers will encounter the problem of figuring out how to augment their service capabilities. I believe that STRP could be in a key position to solve part of this problem and profit off of this profound data growth.

According to some sources, mobile data traffic is expected to grow by 300% in upcoming years primarily due to increases in mobile web and video usage. Below is an graph outlining mobile handset data usage (courtesy of TechCrunch)

The explosion of mobile cell phone usage has brought with it a need to update mobile infrastructure. The familiar macro cell towers, pictured below, cannot keep pace with demand.

As a result, many mobile carriers and infrastructure providers are exploring the use of small cells (pictured below).

Small cells provide the same functionality as large cellular towers.  However, they are optimally suited to serve a smaller population contained within a smaller radius. Previously, in order to provide cellular service to a modestly sized population, it made sense to build fewer large cellular towers as opposed to multiple small cells, as it was more expensive to install several small cells in a given area rather than build a much smaller number of macro cells.

Today, the mobile data industry’s economies of scale are shifting towards the increased use of small cells.  This will be a boom for industries involved in the installation and maintenance of small cells. STRP’s Spectrum is in an especially beneficial position to benefit from the explosion of small cell growth due to its holdings in important frequency domains: more on this will be explained later on.

More on Small Cells

Wireless Internet can be provided in two primary ways on mobile phones. First, let’s go over Wi-Fi. Many homes have Wi-Fi adapters/routers. Some cities, such as Arlington, Virginia, are installing universal Wi-Fi adapters such that anyone can access Wi-Fi throughout the city.  When you are accessing Wi-Fi in your home or in a city with universal Wi-Fi, you make use of bandwidth to connect to the Internet.  This bandwidth is provided by the Wi-Fi router/adapter, and there is only a fixed amount of bandwidth available per Wi-Fi adapter/router.  For these reasons, retrieving data from the Internet on a public Wi-Fi network (i.e. a network provided by a city or at Starbucks) will take longer than retrieving data from a private network (i.e. a network centered on a Wi-Fi router in one’s home).

Mobile phones can also access the Internet via 4G technologies. One can think of 4G as a set of standards, which describes the technologies that must be possessed by phones with the 4G designation.  In this report, the actual technologies behind 4G will be treated as a black box.  The most important aspects of 4G technologies are that mobile phones transmit data to and from the Internet wirelessly and that cellular towers act as the middlemen between 4G mobile phones and the Internet.

Historically, these cellular towers have been the enormous, obelisk type structures characterized by flashing red and white light, but they are not the only type of middlemen in the 4G Internet network.  In fact, cellular towers, which are sometimes referred to as large cells or big cells, have younger cousins which can often be much more versatile and nimble.  These cousins are known as small cells, and they could revolutionize mobile communication and data transmission to and from the Internet.

A small cell provides the same functionality as a large tower. The main difference is that small cells are, by definition, smaller, which allows them to be placed in locations traditionally not suited for cellular towers, such as behind lampposts or traffic lights.  This enables small cells to be placed directly in 4G trouble spots – areas where geography or architecture blocks some 4G signals – as well as areas where too many people connect to the internet at the same time, leading to lower bandwidth, slower download speeds, and dropped calls. For instance, small cells can be placed in sports stadiums, busy subway hubs, or an intersection in a city. AT&T, Sprint, Verizon, and T Mobile have all begun or plan to begin testing and implementing small cells, and small cell demand seems poised to take off.

It might seem as if small cells are a panacea to mobile communication, but there are still lingering problems. The most major problem is linking the data sent to and from the small cell to a wider network.  That wider network could refer to the Internet, and it could also refer to a big cell tower (for the purposes of mobile specific communications such as sms or phone calls).  The process of linking the data sent to and from the small cell (sometimes referred to as the small cell network) to a wider network is termed backhaul.  One of the reasons why backhaul has been so difficult with small cells is that small cells are often located in hard-to-reach areas.  Furthermore, backhaul has generally been implemented using physical cables and/or fiber optics.  These are costly to install and are impractical to place in sparsely populated areas or around traffic lights or stop signs (for a better visualization of backhaul, see appendix A).

STRP’s spectrum business attempts to save the day with backhaul. Backhaul can be implemented wirelessly through communication similar to radio waves. These radio waves must be broadcasted at frequencies within the range of 40-60 GHz.  The amount of frequencies in this range is fixed and regulated by the FCC; companies must obtain a license in order to broadcast frequencies within this range.  STRP holds many of the best licenses within this range (about ⅓ of all “39 GHz” – a label for the range of 38.8 to 40 GHz – licenses, the most of any one entity in the U.S.). These “39” GHz frequencies are the most attractive in the 40 – 60 range because they offer a balance of strong bandwidth with wide broadcasting range (the higher the frequency the stronger the bandwidth but the lower the range). Moreover, STRP’s 39 GHz licenses have great coverage of the largest U.S. metropolitan areas.  Hence, mobile telecommunications companies and Internet Service Providers (ISPs) will likely be very interested in purchasing from STRP the rights to broadcast backhaul at the frequencies for which STRP holds licenses.

Given that the amount of small cells is likely set to explode and that STRP essentially controls the frequency usage for the wireless backhaul bottleneck for small cell usage, they are ideally positioned to profit from this boom. Small cells have to this day been costly to implement and maintain since many small cells must be installed and maintained in order to provide the same functionality for a given geographic area as a big cell tower.  However, costs are quickly lowering, and given the advantages of wireless backhaul, it is likely that costs will lower even further, paving the way for a boom in small cell usage.  STRP’s Spectrum business will be a major player in small cell communications, and given that its costs will remain low since it is an intangible assets company, the Spectrum business could profit tremendously.

Spectrum Valuation

The best-case scenario for STRP (and management’s current plan) is for them to partner with one of the major telecom operators for a nation-wide rollout of their spectrum. STRP would license their entire spectrum to the telecom operator at a discount to current licensing prices, and STRP would pay out a majority of the licensing proceeds out to shareholders through dividends.

In trying to value STRP, we realized just how many misunderstandings there are in the market about the pace of small cell deployment. For example, the company’s investor presentation cites Small Cell Forum data saying there will be 3.5 million small cells in the U.S. by 2015. This leads the investor to think that STRP’s potential market will be 3.5 million cells. However, after speaking with several members of the small cell forum (including the Chairman), we discovered that the 3.5 million figure included femto cells, which are used for more residential use and are unlikely to use STRP’s spectrum. Therefore, the more relevant estimate for STRP’s relevant market is a fraction of the 3.5 million—only 5-15%.

In a more recent 2013 report, the Small Cell Forum has suggested another, potentially more accurate, way to arrive at the number of non-femto small cells in the U.S in the future: According to Informa, the number of small cells worldwide will reach 91 million by 2016. In a chart on page 16 of “Small Cell System Overview” by Andy Germano, VP Americas of the SCF (copied below), Informa breaks down the proportion of these 91 million that will be femto and non femto (we measured that about 5.2% of all small cells worldwide will be non-femto). If we allow for 10-20% of these to be in the U.S. (The U.S. currently has about 14% of worldwide Small Cells, and in 2012, Fibertower projected that by 2019, 10-15% of small cells would be in the U.S.), then we can arrive at a number for non-femto U.S. small cells by 2016. (91*.052*.15) or about 700,000 small cells. Below is the Informa graph:

Small Cell Roll-Out Scenarios

To illustrate the potential upside of their spectrum, consider the following assumptions:

  • 2016 world-wide, non-femto small cells
    • Bull: 5,000,000. Base: 4,500,000
  • Percentage of small cells in the U.S.
    • Bull: 20%, Base: 15%
  • Resulting U.S. Small Cells (Output)
    • Bull: 1,000,000. Base: 675,000
  • Percentage Wireless
  • Percentage of Wireless using 39 GHZ
    • Bull: 90%, Base: 60%
    • 39 GHz offers a great balance of bandwidth (signal strength) and range. For instance, it offers more bandwidth than the Non Line of Sight frequencies, and it offers more range than the 60+ GHz frequencies (it is also cheaper than the latter). Also, because 39 GHz is licensed, the signals will not interfere with other radio signals, so there should not be many FCC roadblocks to implementing small cells on this frequency. Lastly, 39 GHz is a great range for both point to point and point to multipoint backhaul, so it is versatile.
  • STRP Market share of 39 GHZ spectrum
    • Bull: 30%, Base: 25%
    • Of these non-femto, wireless U.S. small cells backhauled over the 39 GHz frequency, we think that STRP can get at least a 25% market share. They currently ~1/3 of the licenses for this frequency, but we think that their market share could be higher (so these estimates should prove to be conservative). This is because STRP has the competitive advantage of being the only company able to offer nationwide backhaul on the 39 GHz frequency. In fact, the STRP Spectrum covers about 99% of the United States.

( Furthermore, we assume one link/small cell in all scenarios.

  • These assumptions would lead to STRP providing 229,500 links in the bull case, and 55,910 links in the base case. This is a wide range (given all of the uncertainty about timing of roll-outs and many important assumptions), but they seem realistic. For example, AT&T plans to implement 40,000 small cells by 2015, and calls this a “trial.” Certainly if AT&T or another major player went nationwide with STRP, then there could be hundreds of thousands of small cells for STRP to backhaul.
  • Revenue/link
    • Bull: $200, Base: $150
    • Revenue per link is currently about $350, but the price could decrease considerably if a carrier makes a nationwide deal.

These assumptions would result in $8.4 million in 2016 revenue in the base case and $46 million in revenue in the bull case. This would be extremely high-margin (~85% EBIT margins) and minimal capex. Even if we ignore their tax credits and apply a normal 35% tax rate, this would result in $4.3-$25.3 million in net income to STRP each year. Even assigning an S&P-like multiple of 15X to this future income and discounting this back at 15% results in a NPV of the spectrum of $43-$250 million. This also ignores cash flows before 2016, which will be ramping up quickly.

Obviously, that would be a jackpot for investors, but this is not the only important consideration. Even if STRP fails to reach a deal for a national roll-out with a telecom operator, they could still sell them their spectrum licenses in particular markets. For example, in 2012, Metro PCS bought four 39 GHZ licensees and four 28 GHZ licensees for $6.8 million, or $850K/license. From speaking with management, I got the sense that the sale included licensees that were in good markets, but not necessarily “top tier” markets. Below, I have valued the licensees in two ways. The first is a Price/MHZ Pop method, which I believe is a more accurate way to measure value. The second below it is a simple price/license method, which is not quite as accurate in my opinion, but a bit more intuitive and similar results.

MHz x Population Valuation

Service Area  Population  Licenses  Total MHz  Mhz x Pop
 New York-No.NewJer.-Long Island             26,663,330                          7                               700        18,664,331,000.0
 Los Angeles-Riverside-Orange County             19,800,937                          5                               500          9,900,468,500.0
 Chicago-Gary-Kenosha             10,758,118                          9                               900          9,682,306,200.0
 San Francisco-Oakland-San Jose               9,759,108                          5                               500          4,879,554,000.0
 Dallas-Fort Worth               9,092,705                          8                               800          7,274,164,000.0
 Boston area               8,228,930                          7                               700          5,760,251,000.0
 Philadelphia-Wilminton-Atl.City               7,735,541                          7                               700          5,414,878,700.0
 Houston-Galveston-Brazoria               6,949,709                          9                               900          6,254,738,100.0
 Detroit-Ann Arbor-Flint               6,827,726                          7                               800          5,462,180,800.0
 Atlanta               6,690,595                          7                               700          4,683,416,500.0
 Total           112,506,699                        71                            7,200        77,976,288,800.0
 Miami-Fort Lauderdale               6,291,880                        10                            1,000          6,291,880,000.0
 Minneapolis-St.Paul               4,895,391                          9                               900          4,405,851,900.0
 Seattle-Tacoma-Bremerton               4,686,669                          8                               800          3,749,335,200.0
 Denver-Boulder-Greeley               4,685,203                          7                               700          3,279,642,100.0
 Cleveland-Akron               4,583,408                          6                               600          2,750,044,800.0
 Orlando               4,562,642                          6                               600          2,737,585,200.0
 Phoenix-Mesa               4,351,644                          8                               800          3,481,315,200.0
 St.Louis               3,690,263                          9                               900          3,321,236,700.0
 Indianapolis               3,335,590                          7                               700          2,334,913,000.0
 Portland-Salem               3,311,677                          7                               700          2,318,173,900.0
 Pittsburgh               3,095,313                          6                               600          1,857,187,800.0
 Nashville               2,912,497                          7                               700          2,038,747,900.0
 Tampa-St.Petersburg               2,856,296                          6                               600          1,713,777,600.0
 Clearwater               2,783,243                        10                            1,000          2,783,243,000.0
 Total           281,055,114                      248                          25,000      121,039,223,100.0

(USD in millions)

                1  Assume an Atlanta-like market for the avg. license sold in 2012
                2  Calculate the implied P/MHZ*Pop per license sold in 2012
                3  Multiply the implied price/MHZ*pop by the total MHZ*pop to calculate total value
                4  Apply discounts to the 2012 $0.85 mm sale/license to gauge range of values
                5  Analyze by both top 10 markets and total value
 Bear  Base  Bull
 2012 Price/lic sale (mm) 0.26 0.43 0.85
 Implied % of 2012 sale 30% 50% 100%
 Atl. MhzPop (mm) 4,683.4 4,683.42 4,683.42
 License # 7.0 7.00 7.0
 Price/MhzPop (per lic.) 0.000385 0.000635 0.001270
 Value of top 10 markets  $30,000,000  $49,532,101  $99,064,202
 Value of top 24 markets  $46,567,703  $76,886,540  $153,773,079
 While we believe the MHZ*Pop method is more appropriate, one can also value the spectrum on a per license basis. This results in the top 10 markets being less valuable, but overall spectrum worth more
 Value of top 10 markets                        18.3                     30.2                              60.4
 Value of top 24 markets                        63.8                   105.4                            210.8

Therefore, in my base case, the two methods suggest that the spectrum on an asset sale perspective is worth somewhere between $30 mm and $105 mm. Note that this is only using a fraction of their total licensees (only top markets).

Furthermore, management rejected an offer in 2010 for their entire spectrum for $30 mm. This seems like a reasonable bear case because no investment banks were hired to market the spectrum, and it did not seem like a value-maximizing, formal sale offer process. Furthermore, using the MHZ*Pop valuation method, one has to take some drastic assumptions to get to $30 million value: in the bear case, if you take only 30% of the 2012 sale and only include their top 10 markets, you reach a value of $30 million. That seems like an appropriate margin of safety.

Sum of the Parts Valuation

Patent Valuation Low Base High High w/nat.roll-out
Total Proceeds from Lawsuit $25 $100 $175 $175
Max Value (40%) to K&E $10 $40 $70 $70
Net Lawsuit proceeds $15 $60 $105 $105
STRP’s stake 84.5% 84.5% 84.5% 84.5%
Total Patent Value to STRP $12.7 $50.7 $88.7 $88.7
Spectrum Valuation Low Base High National Roll-Out
Value of Spectrum $30.0 $49.5 $99.0 $250.1
Value of Business $42.7 $100.2 $187.7 $338.8
Discounted Cash $10.0 $10.0 $10.0 $10.0
Total Value $52.7 $110.2 $197.7 $348.8
Value/Share $4.58 $9.58 $17.19 $30.33
Premium/Discount -14.4% 79.1% 221.4% 471.3%


Risk is always related to the price paid. In STRP, many “risks” that people might claim for reasons to pass on the investment do not really exist at a $45 mm enterprise value. One does not need a small-cell national roll-out with a major telecom operator on STRP’s 39 GHZ frequency in order for this to be successful. Similarly, one does not need a record-setting victory in trial for Kirkland & Ellis. At the current price, even piecemeal sales of the spectrum at severe discounts to the 2012 Metro PCS sale and several medium settlements on the patent side would lead to a strong return. That being said, there are still some real risks in this investment:

  1. Jonas family control is lessened by trust structures. While their incentives seem to be aligned, that does not mean they will not somehow attempt to take advantage of minority shareholders. That being said, Howard Jonas has driven tremendous value in IDT.
  2. If the patents are somehow invalidated and Kirkland & Ellis was wrong about the potential value, then the patents would not provide the downside protection that I am counting on in this investment. While this is conceivable, I think that K&E is more properly valuing the patents when they decided to take the case on a contingency basis than most of the investors I have spoken to who have simply ignored the stock because they are not IP experts.
  3. Small cell wireless backhaul over 39 GHZ does not take off as planned. There are several competing technologies (fiber, other frequencies, etc.). However, I think that the demand for backhaul is so great that there will likely be many solutions that are used to solve the nation’s data problem. I expect STRP’s frequency to play a role in part of that. To the extent I am wrong, there could be downside in the stock.

One other final note on risks is that even though it is conceivable that K&E is wrong and the patents are worthless and that 39 GHZ ends up not being used for wireless backhaul, both of these bets are independent of each other and themselves are not binary. Like I mentioned for the spectrum, there is likely substantial value even in a piecemeal sale. With the patents, there are multiple lawsuits over many firms, and settlements are the most likely outcome. Therefore, I think some investors are failing to understand the actual risk in this investment because they view it as a lottery ticket on the spectrum assets, rather than two different bets on uncorrelated intangible assets with a wide range of  outcomes, and the “smartest people in the room” (Howard Jonas, K&E) indicating great upside in the stock.


It is difficult to put a precise estimate on the value of STRP’s intangible assets, but it is not difficult to see that it is a great risk reward at the current price. Even taking the $30 million rejected sale for the spectrum in 2010 and $12 million for the IP, the enterprise value is nearly fully covered at today’s price. This type of downside protection is extremely rare for a company with multi-bagger potential. I believe that betting alongside Kirkland & Ellis and Howard Jonas on the patents will prove to be a shrewd move, and that the patents likely cover the entire enterprise value. Furthermore, the spectrum is an extremely valuable call option that is NOT a binary bet, since even in a worst-case scenario, STRP could sell off some of the spectrum piecemeal. I believe fair value is around $9.58 range, which represents 79% upside from current prices, but there is substantially more upside in very reasonable scenarios making this a fantastic risk/reward from the current price.

Works Cited / other reading

My Favorite Stock in 2013 and Beyond– 200%+ Upside

At first glance, one may overlook the tremendous value in Noble Roman’s (NROM). It has been around since the 1970’s, has a ~15 mm market cap, and trades for less than $1. However, for the few investors who are willing to take a closer look, an extremely compelling story is emerging. After falling from over $7 during its 2007 peak, NROM trades at ~$.70 despite an extremely favorable business transformation that is so far unnoticed by the market. In five years, I believe the company will be have 60%+ operating margins (~40% ttm) and generate over $9 mm in EBITDA (~$3 mm in 2012). Today, you can buy into this growth story at just above book value and 6X ttm EBITDA. I conservatively value shares at $2, greater than 200% upside, but if their new “Take N Bake” franchise concept is successful (as early signs indicate it will be), this could be a true homerun and conceivably be worth ~$6.

Since very few investors follow the stock, I will give a brief background on the company and describe their various business segments.

Company Background

  • Began in 1972 as a small Indiana pizza operator
  • In the 1980’s and 90’s phased out of the operating store business
  • In the 1990’s and early 2000’s, the company morphed into a franchising and supply chain pizza business
  • In 2008, the company was sued by many of their franchisees who accused Noble Roman’s of fraud as a result of the dramatic failure of most the of the franchises
    • The company spent a couple million in legal payments company and is currently trying to recoup up to $5 mm in counterclaim payments.
    • The judge has already ruled in NROM’s favor, completed dismissed the lawsuits as frivolous, and there is a hearing in mid-February with possible payments to NROM for legal fees.
  • In 2009, the company began focusing its efforts on selling “take n bake” pizzas to grocery stores
  • In 2012, the company started another new segment, focused on opening individual “take n bake” franchises, modeled after Papa Murphy’s success in this market

The Business Segments: The four major segments listed here are described in detail below. Revenue percentages below are based on estimated full year 2012 results.

  • Non-Traditional Locations (58% of revenue)
  • Take-N-Bake Grocery Stores (18% revenue)
  • Traditional Locations (12% revenue%)
  • Take-N-Bake Franchise (1% revenue)
  • Other (11% of revenue). I won’t cover other as it is insignificant (consisting of a couple company owned stores for testing purposes) that have had very consistent operating results, but are not a major source of value (and will shrink as % of revenue going forward).

Non-Traditional Locations

  • This is basically convenience stores/ gas stations. Noble Roman’s sells stores the equipment to make Noble Roman’s pizza (upfront fees) and NROM takes a % of sales as a royalty fee. This is a high margin segment for the locations and a great proposition for Noble Roman’s as well.
  • This is a very sticky business with essentially no costs. Once a location has the equipment, they have little incentive to switch. This makes the segment very easy to value/model
  • Below are the results from this segment (2012 full results estimated)

The company has done a good job growing relationships with large operators of non-traditional locations. For example, it now has a relationship with The Pantry, which has 1,650 locations (see investor presentation). This is a sticky business segment that should at least maintain revenue, and more likely, slightly grow over time as they continue to roll out new units with existing operators of these locations

            2010            2011     E2012
non traditional roy fees           4,425,822         4,023,177   4,340,000

Take and Bake Business (Grocery Stores): ~18% of Revenue, Growing

  • This is the company’s current main growth segment. They started selling “take-n-bake” pizza to grocery store chains in September 2009. These are made that day (non frozen) pizzas that are refrigerated and are taken to a customer’s home to cook and eat that day.
  • The Company has signed agreements for 1,350 grocery store locations to operate the take-n-bake pizza program and has consistently added ~400 stores per year.
  • Each store generates ~$2000/year (ramping up slowly). ~$1.16 accrues to NROM/pizza
  • Again, the company has essentially no costs associated with this segment as they are licensing their brand. The company develops distribution agreements with grocery store distributors, signs licensing agreements with Grocery distributor customers, and services them through foodservice distributors

Individual Take N Bake Franchises

  • Papa Murphy’s is the leader in this fast growing take n bake market. With over 1,300 locations, they are the 5th largest pizza chain in the U.S. and are expanding quickly
  • These locations serve pizza that can be customized when ordered and are then be taken home to be baked. It is fast and cheap.
  • One key competitive advantage is that their food is not considered a finished good, and is therefore eligible for food stamps. Papa Murphy’s has 22% of their sales from food stamps. This gives them a competitive advantage over other dining concepts.
  • Papa Murphy’s is the only major player in the market. The biggest players (Pizza Hutt, Dominoes, etc.) are unlikely to enter the market given it would threaten and cannibalize their existing brand image.
  • NROM believes it is well positioned to enter this market (again via franchising.. another growth vertical that does not risk company’s own capital). There are already two in existence and six more already in agreement. The company’s first store generated an operating profit of 26.5% in its first month of existence
  • The company takes 11% of all sales, and units are estimated (based on Papa Murphy’s financials) to bring in ~$550K/year, leading to $50K+ in revenue to NROM per year

So How Much Is It Worth?

  • The CEO has stated they can double the size of the business with almost no increase in costs. This is the real beauty of their business model—almost all incremental revenue will flow to the bottom line
  • In 2012, the company should generate ~$3 mm in EBITDA based on $7.5 mm in revenue and $4.5 mm in OPEX.
  • I think the company can generate $9 mm in EBITDA in 2017
    • Assumes non-traditional revenue growth is flat (conservative)
    • Assumes the company can continue to sign 400 grocery stores per year for five years. By the end of 2017, this would be 2,000 additional grocery stores. At ~$2,000/grocery store, this results in $4 million in incremental EBITDA
    • Assumes the company will be operating 40 individual take n bake stores by 2017, generating on average $50,000 to NROM/year. This results in an incremental $2 million in EBITDA.
    • Adding this growth to the existing $3 mm in EBITDA gets you to $9 mm in 2017 EBITDA, but how much is that worth?
    • On low end, I believe an asset-light, growing company with 60% EBIT margins would be worth an S&P 500 average multiple (currently 9.32X EBITDA).
    • On high end, I have used PZZI (closest comp) 20.68X EBITDA. Note that PZZI has less than 2% EBIT margins and less EBITDA than NROM despite 2X market cap.
2017 EBITDA Multiple                              9.32 PZZI EBITDA Multiple                      20.68
2017 EV                 87,773,904 2017 EV         194,760,122
Debt                 (4,900,000) Debt            (4,900,000)
Equity Value                 82,873,904 Equity Value         189,860,122
2017 Equity Value/Share                              $4.25 2017 Equity Value/Share                         $9.73
DR 12% DR 12%
NPV/share $2.41 NPV/share  $              5.52
Premium 209% Premium



Am I Crazy? Are These Assumptions Too Optimistic?

  • If you are anything like me, and you are unfamiliar with the story, your inner value investor may be cringing at the above tables. After all, aren’t those growth estimates just pulled out of thin air? Isn’t the take n bake individual franchise concept barely starting for NROM, making a 20X increase in stores (to 40) by the end of 2017 ridiculous? Let me explain…
  • First, under the above 2017 scenario, here is how revenue breaks down per operating segment:

2017 % Revenue

Non traditional roy fees


Grocery store take n bake


Traditional locations


Restaurant Revenue


Upfront Fees


Take-n-bake franchise


Total Revenue


  • The most valuable business segment is the grocery store segment. This also happens to be the growth segment with the most visibility. The company has for three years now built an impressive business segment from scratch, and they have a long runway for growth.
    • Sanity Check: Can they average 400 stores/year for five years?
      • They have signed 1,350 stores in three years. They already have relationships with 14 grocery store distributors that represent over 5,000 stores.
      • The number of grocery store distributors is rapidly increasing as well—already to 14 after Q3 2012 after only 10 YE 2011. At their last industry trade show, the company said they had “leads for 6 new grocery distributors and 30 chains representing 3,134 units”
      • Growth has been accelerating, not decelerating. Through only three quarters of the year, NROM had signed 411 grocery stores this year.  That puts them on pace for 548 this year, well above my run-rate estimate going forward
      • Independent channel check: spoke with a grocery distributor who confirmed that NROM is doing very well with grocery store traction and he expects continued success.
        • Conclusion: 400 grocery stores per year should be manageable for the next five years
  • Individual Take N Bake Franchises
    • Can they get to 40 stores by 2017?
      • Company already has two in existence and six more in agreements for 2012.
      • The take n bake concept has already been proven viable by Papa Murphy’s and NROM is in an ideal position to enter the market
        • NROM franchises are much cheaper to start (~80K) vs. Papa Murphy’s (250-275K) and early indications hint at similar economics
        • CEO has stated he thinks they can get 50 by 2013. This is probably too aggressive (but wow if he is right this would rerate fast), but they are in talks with larger franchise operators to open many units (20+)
        • Conclusion: The Take N Bake market is growing (Papa Murphy’s plans to open 100+ stores in 2013). NROM is the only other real player in the market now (and the large players don’t want to participate), and if their new stores show continued success, they should be able to quickly grow given Papa Murphy’s is 3X as expensive to open. This is admittedly the hardest segment to value, but at the current market price, it is more of a free call option than anything else. You can value this at zero and the stock is still a big winner.

Concluding Thoughts

You can certainly argue on the margins with some of my assumptions: perhaps NROM falls short of adding 400 grocery stores per year, the non-traditional location segment has a small decline, the take n bake franchise concept does not take off, and operating expenses slightly increase. However, at a price of $0.77, representing just above book value, these segments can underperform my expectations and I can still have a very profitable investment given the huge margin of safety. I think the market has ignored this stock and that early investors that jump on this story and have the patience to let it develop will end up with very satisfactory returns. I peg fair value from $2-$6, an admittedly wide range given the potential in the take n bake market. Even the low end of the range represents over 200% upside from the current price.

Why This Opportunity Might Exist

  • $15 mm market cap—under the radar of almost all institutional investors
    • Also zero write-ups on SZ or VIC
    • Trades for less than $1
    • Many shareholders have “puked” this stock out after its precipitous decline from over $7 in 2007
    • Multiple business changes over time have confused and caused doubt to investors


  • Management is paid handsomely for such a small company (but they also own lots of stock)
  • CEO is on the older side and plays an important role in the company
  • Capital allocation—this is always a risk in a business that does not need a lot of investment. I feel the risk is small here though (but still exists) because management has indicated they will use cash flow to pay down debt, and then initiate a dividend

Other Reading

A Nine Point Checklist to Improve Investment Decisions

Checklists are used by some of the worlds best investors. For example, see Monish Pabrai’s reasons for using checklists. It’s a great presentation here:

The following is a recent nine point investing checklist I compiled after looking at some of my biggest winners and losers. I am going to try to continually add to this list and use it in my investing process. Let me know in the comments section or on Twitter what you think of this checklist, or any other points you use in your checklist investing process.

Investing Checklist—Winners/Losers

  1. Is this a simple business that I can understand? Can I explain it to a third grader?
  2. What do the smartest people in the room (management, large shareholders) think about the stock? At what price have they liked it/ not liked it? Have they publicly said their stock is cheap? Do you understand the incentives of everyone involved? Management, majority stockholders, etc?
  3. Do I understand the history of the business? Do I love the company independent of stock price? Is this a business I will be a passionate partner of, or merely a stock that looks cheap?
  4. Does the company have a competitive advantage? How is this reflected in the financials?
  5. How does the stock trade today and are you confident you understand what others think about it in the market?
  6. Where does the stock deserve to trade? If there is a variant view from the market, what is the exact source of that view?
  7. How much time have you put into researching this company, its history, and its competitors? Is this a business you want to bet your year on? Your career? Or is this a smaller, more speculative position?
  8. ~50% of a stock’s move is industry driven– what are the key trends in the industry and which firms do they favor? Is this a situation or industry with uncontrollable risks? How do you lose in this investment?
  9. What is the margin of safety? Explain it to someone else who tries to poke holes in it. Is there a margin of safety in both the business and the price paid?

Company updates and portfolio activity: LVB, NROM, SHFK, EVI

In this post, I will briefly mention SHFK and EVI, two of my favorite current holdings. I will then update NROM which had a very strong Q3 and discuss LVB which had a slightly disappointing Q3 announcement.


I continue to really like this stock. While it basically does not move and it took me awhile to establish a position, it’s hard to imagine how you lose here. Trading at half of book value and 2.2X mid-cycle earnings and a flexible cost structure, this is a slam-dunk IMO. The fact that management bought back 57% of shares last year is incredibly beneficial to shareholders and shows what management thinks of the stock. They only file once/year, but I am expecting a very solid report out of SHFK around year-end.


I found this idea originally from Shaun Noll who has been in the stock for a long time and knows it extremely well. I may do a full write-up on it later but here is the quick pitch from my perspective. The cheap valuation, simple business, and the fact that the company is paying a $0.60 special dividend on a ~$2.00 stock by the end of the year caught my attention.

It’s a $15 mm stock that has over $10 mm in cash. The company is a distributor of laundry equipment to individual stores/ franchisees. It’s an extremely simple business that has had very stable financial results—even during the Financial Crisis. I estimate the company’s worst-case scenario run-rate net income (which in this case approximates FCF… insignificant capex/depreciation) at $500 K. Since the company is 60% insider owned and seems intent to return cash to shareholders (and themselves), I think valuing the company on an EV basis is appropriate (as market cap should move towards EV as mgt. returns cash). Therefore, even using worst-case earnings, the company trades at a better than 10% EV/FCF yield.

Now, I wouldn’t buy the stock if I thought it would give me only 10% returns. I am just highlighting that even in a worst-case scenario, that’s a pretty solid yield for a stable, simple business and it gets me comfortable with the downside. The company had a record backlog last quarter and could make as much as $1.5 mm in net income in 2013. Under this scenario, the company could easily trade to ~4.00. I love heads I win big, tails I make 10% on a simple, stable business. I think the company is likely to post a big 2013 and management will attempt to buy out the whole company.


NROM is a micro-cap company that I continue to really like at this depressed price. They released very strong Q3 results. Here are my key takeaways:

  • Operating margins came in pretty high at 39.3%. I have conservatively modeled in 35% margins in my valuation scenarios so this was nice to see
  • Upfront franchisee fees and commissions were $311,022 compared to $185,491.
    • This is important because it indicates that the non-traditional segment is still healthy, which is currently their most valuable business segment.
  • Overall revenue increased 2.3% compared to last year. This number is actually artificially low because their new grocery store sign-ups take time to start being implemented. As I noted in my original write-up, this is the key growth driver and an important thing to watch…
  • 2012 YTD, they have already signed 411 additional grocery store take-n-bake locations.
  • The first stand-alone take-n-bake location opened in Greenwood, IN, a suburb of Indianapolis, on October 29, 2012; six more are already under agreement and in various stages of development, several of which are expected to open soon

Conclusion: NROM is very much on track. Note that in my “Bull” scenario valuation of $1.67/share, that factors in about 400 grocery store signings/year and 35% margins. With a full quarter left in 2012, they are already at 411 stores signed and have higher operating margins. They also are showing progress on the stand-alone take-n-bake stores, which I decided to leave out of my model as pure upside (difficult to say predict how it will take-off). Management seems to be optimistic—and I have heard reports suggesting their new opening is going well. NROM is very much a developing story and the thesis is on track. I continue to patiently hold shares and think the next 12-18 months will be good ones for NROM shareholders.


Back in September, I highlighted the Sum of the Parts value of Steinway Musical Instruments (LVB). I laid out my high and low estimates for fair value for all of their assets and deemed prices fairly valued to 87% undervalued. The company previously said they would announce the results of strategic alternatives by the end of Q3 (September). Well, on the latest conference call, there was mixed news.

Good news: They announced an agreement to sell their West 57th Street property—monetizing a non core asset and showing the first tangible progress of the strategic review.

Bad news: An unanticipated chunk of the value is going to the landowners, rather than Steinway (the building owner). Furthermore, the rest of the strategic process is taking longer than expected—leaving shareholders in the dark during an expensive process.

From their conference call:  As a reminder, Steinway owns the building on 57th Street subject to a long-term land lease. “The proposed transaction will be with us and the landowner as sellers. The total purchase price for the combined property is $195 million, with $56 million coming to Steinway. $20 million of the $56 million will be held in escrow until we vacate the space we currently occupy in the building. The letter of intent stipulates that 12-month advanced notice be given by either party with respect to vacating our space.

We expect to complete negotiations of a purchase and sale agreement within the next 15 days. Of course, no

assurance can be made that a definitive agreement will be ultimately signed, or that it will be signed in the time frame we anticipate. We currently expect the closing to take place before the end of 2012”

While I knew LVB did not own the land, to have only 28% of the value go to them was definitely not what I expected. Other analysts seemed pretty surprised as well. From conference call:

It’s Rick D’Auteuil, Columbia Management. The information disclosed on the purchase price or the sale price of the 57th Street property in total and then your allocation — can you talk about is — was there a fixed formula, or was that negotiated on how the split was? Because the total amount is consistent with some of the prior numbers I’ve heard about the valuation there. The split surprises me, so what’s the justification for that?”

How does this affect the investment?

I originally valued LVB’s stake in the West 57th property at $50-$100 mm, so the $56 mm is near the low end of my valuation. This lowers the high valuation from $47 to $43, not a huge move. More concerning though is the delay in the strategic review process. At this point, management has overpromised and under-delivered—and it is clear investors are growing frustrated. With little transparency in such an important process and the West 57th street sale coming in near the low range, I am less bullish than I was before. While I still think the risk/reward is favorable, it is no longer as large of a position for me.

Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.


Schuff International (SHFK): Cheap, Ugly, and a Potential Multi-Bagger

Fellow blogger Nate Tobik recently had a great write-up on Schuff Steel calling it a potential 10-bagger. I really respect Nate and enjoyed the write-up, so I decided to take a deep dive into the company:

Investment Overview

Schuff International is cheap at less than half of book value, ugly as a cyclical and highly levered construction company, and a potential multi-bagger with the continued recovery in construction spending. While casual onlookers of the stock may view it as extremely risky— high debt load, big debt maturity in 2013, and a nano-cap with limited disclosure, this risk is misunderstood, creating an extraordinary cheap stock for current investors. The company’s management seems to agree—having retired over half of the shares in the past year at a huge discount to book value.  I believe the stock is a great risk/reward at current levels and is conservatively worth ~$20, nearly a double from current prices.

Key Metrics

  • Market Cap: $42.5, EV: $90.69M
  • Price/Book: 0.48
  • Price/Sales: 0.11
  • EV/EBITDA: 6.85
  • Quarterly Revenue Growth: 77.20%
  • Debt/EBITDA: 4.22
  • Altman Z-Score: 2.82 (within the safe zone)

Business Overview

Schuff International is the largest steel fabricator/erector in the United States. For those unfamiliar with industry, this essentially means that they take steel and alter it to fit the needs of a particular construction project. This is a very fragmented industry because it is very costly to ship large amounts of extremely heavy steel, which is why a $45 mm mkt cap company can be the largest player in the U.S. Schuff operates in Arizona (company headquarters are in Phoenix), Florida, Georgia, Texas, Kansas, California and the New York City area. They typically are paid with a “cost-plus” model and do not have significant customer concentration risk with their largest customer representing 11% of sales in 2011 and no other customers over 10%.

This business is very cyclical, but should be profitable throughout an entire cycle. For example, as recently as 2008, the company made over $97 mm in EBITDA, greater than twice their market cap, and $57 mm in net income. However, the 2008 crash really hurt construction and their latest annual EBITDA and net income is $13.2 mm and ($5 mm) respectively. With such a cyclical industry, investors have seemingly been scared by the company’s high debt load and sold the stock from its $35 high to just over $10, which represents half of book value.

I believe this massive sell-off is undeserved for three reasons:

1) While the company is certainly cyclical, it is also very profitable

From “trough to trough” in the construction market (2003-2011, see chart below), the company’s average unlevered FCF was $20.48 mm, which makes the normalized FCF yield over 22%. Furthermore, the company’s costs are highly variable, which allows them to cut employees and close plants during tougher times in the construction market and thereby avoid disaster years. The company has not had a single year of negative EBIT since 1995 (as far as my data goes back).

2) The cyclicality is somewhat predictable and is currently near a trough

Using national data from the Census Bureau on construction spending, I developed a regression model to forecast Schuff’s quarterly EBITDA. Inputs: Nonresidential Construction Spending and Total Construction Spending. This model is actually very effective in explaining SHFK’s quarterly EBITDA with an R squared of .84

Key Takeaway: Schuff’s quarterly success is so cyclically-based that it is possible to predict their EBITDA using only “national” data suggesting their cyclicality is simply a product of the industry, which should snap back, rather than company specific downturns.

While SHFK has zero analysts covering the stock, is extremely illiquid, and does not offer annual guidance, one can use the model above to predict their EBITDA based on readily available estimates for national construction data. As seen below, analysts are predicting a strong rebound in Nonresidential construction growth in 2012 and 2013.

Below, I include the same model, but it includes a two year projection for EBITDA based on the consensus estimates for national construction data.

3) The EBITDA prediction model, the company’s incredibly aggressive buyback, and the company’s recent moves suggest its debt is manageable and shares are deeply undervalued

The company has nearly $56 mm in debt, which represents over 4X EBITDA. This is a large amount for a cyclical company, leading some people to believe bankruptcy is possible.

Aggregate debt maturities are as follows:

2012: $26,413,000

2013: $4,000,000

2014: $5,000,000

2015: $19,000,000

2016: $1,410,000

First, realize that the debt repayment schedule is somewhat unusual given its lumpy nature. SHFK has over $7 mm in cash on the balance sheet and the EBITDA model predicts $22 mm and $32 mm in 2012 and 2013 respectively, which would be more than adequate to cover debt requirements.

Perhaps even more importantly, the company’s revenue is also tied to a small number of contracts, giving the company much more visibility into future revenue than any investor, especially since the company only files results once per year.

This is why it is so incredibly significant that the company took on MORE debt last year in order to retire 57% of their shares outstanding at less than book value!

Why would management, which owns the majority of the stock, do this if they were worried about their interest payment one year from now? They would be sued, perhaps file bankruptcy, and have their family name and business tarnished.

President and CEO Scott A. Schuff had this to say about the buyback:

“By completing this transaction, we are taking advantage of a unique opportunity to enhance stockholder value while demonstrating confidence in the long-term outlook for our business…Every Schuff International stockholder now owns a greater percentage of the company by a factor of nearly 2.5. The reduction of the total outstanding shares as a result of this repurchase implies a greater share value for the holdings of our stockholders. We believe that the commercial construction market is at or near the bottom, and we are confident that our strategic vision and the disciplined cost controls we instituted nearly two years ago are allowing us to capitalize more quickly on new projects we see in the pipeline”

Also providing further credence to this idea of a bottom, the company recently re-opened their Orlando plant citing demand in 2013:

“We are seeing signs of increased market activity and plan on re-opening our Orlando plant in the first half of 2013,” said Ryan Schuff, President and CEO of Schuff Steel. “We have also centralized our Southeast operations and revamped our executive management team by adding and transferring some key employees to our newly renovated Orlando office.”

Furthermore, the company has an Altman Z-Score of 2.82, suggesting bankruptcy is very unlikely:

Altman Z-Score: 2.82 (within the safe zone)

  • Formula for predicting bankruptcy
    • Z > 2.6 (“Safe” zone)
    • 1.1<Z<2.6 (“Grey” zone)
    • Z<1.1 (“Distress” zone)

Finally, the company’s balance sheet should protect them from any downturn, making their debt load much less of a concern. Trading below tangible book value, with over $60 mm of that book value in land and buildings is pretty reasonable.

Therefore, while the debt load is a risk and something to watch, everything I have examined suggests it is manageable.

If this sell-off is unwarranted, how much are shares worth?

Valuation Method #1—Value based on mid-cycle FCF

-Note that 2003-2011 was chosen because it represents the last “cycle” from trough to trough (in chart above).

2003-2011 Average Unlevered FCF  $20.48
Discount Rate 15%
Earnings Power Value  $136.51
Value of Debt $55.82
Equity Value  $80.69
Total Shares Outstanding 4.15
Value/share  $19.44
Current Value/share  $10.25
Premium 90%

Valuation Method #2—Value based on mid-cycle earnings

  • From 2003-2011, average net income = $19.2 mm
  • I believe 5-10X earnings is reasonable for a mid-cycle cyclical company
  • Implied valuation: $23- $46/share, 128%-356% upside


  • Management interests may not be aligned with minority shareholders.
    • The family may be trying to take the company private, and in doing so, may be deliberately trying to lower the share price by performing their own LBO
    • Should the company default on all of its debt within a year or two, lawsuits would definitely be filed and shareholders would have strong claims
  • The Schuff Family offered a lowball takeout price in 2006 that was rejected.
  • Very illiquid (Average daily volume 1,600)
  • As a OTC stock, files financial reports only once/year


  • Company is deeply undervalued at .4x book value, 2.2X mid-cycle earnings, and 4.5X EV/ Normalized FCF.
  • Industry is very cyclical (currently near trough) with construction spending projected to grow dramatically. This cyclical company should not trade at trough multiples at trough earnings
  • Management, who is most knowledgeable about the financials, was incredibly aggressive using debt to buy-back stock at a large premium to the current price, indicating how undervalued they consider current shares.
  • The company represents a compelling risk/reward and is conservatively worth ~$20

Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.

Noble Roman’s Inc. (NROM): Simple Growth for Free

Today I want to tell you about a little company called Noble Roman’s (NROM), a stock I recently researched with other members of my Special Opportunities Group—Peter Chase, Eric Hendey, Chaodan Zheng, and Rob Boling. On the surface, it’s a micro-cap pizza company trading for less than $1 that was nearly sent into bankruptcy after defending itself against frivolous lawsuits from its failed franchisees. However, on closer inspection, it’s a simple, sticky business model with high returns on capital and an underfollowed growth opportunity. I believe shares are worth at least $1.13, ~50% above recent prices.

For basic background info not covered here, see company presentation:

The Metrics

  • Market cap: $14.64 mm
  • EV: 20.09 mm
  • P/B = 1.34
  • P/E = 22.06
  • EV/EBITDA = 6.20
  • ROE = 12.27%

Company Background

  • Began in 1972 as a small Indiana pizza operator
  • In the 1980’s and 90’s phased out of the operating store business
  • In the 1990’s and early 2000’s, the company morphed into a franchising and supply chain pizza business
  • In 2008, the company was sued by many of their franchisees who accused Noble Roman’s of fraud as a result of the dramatic failure of most the of the franchises
    • The company spent  a couple million in legal payments company and is currently trying to recoup up to $5 mm in counterclaim payments.

The Business Segments

  • Non-Traditional Locations (62% of revenue)
  • Take-N-Bake (18% revenue)
  • Traditional Locations (12%)
  •  Other (8% of revenue). I won’t cover other as it is insignificant (consisting of some company owned stores for testing purposes)
    • As I describe the business segments, realize all of them have very few costs due to the licensing business model. I think it is therefore appropriate to try and best model out the revenue and assume a 35% operating margin. Note that operating margin has been very stable and generally higher (for five out of last 6 years) than this 35% figure so it should prove to be a bit conservative
  • Non-Traditional Locations (62% of revenue), very sticky business
    • This is basically convenience stores/ gas stations. Noble Roman’s sells stores the equipment to make Noble Roman’s pizza (upfront fees) and NROM takes a % of sales as a royalty fee. This is a high margin segment for the locations and a great proposition for Noble Roman’s as well.
    • This is a very sticky business with essentially no costs. Once a location has the equipment, they have little incentive to switch. This makes the segment very easy to value
    • Below are the results from this segment (2012 full results estimated)
             2010             2011      2012
non traditional roy fees            4,425,822          4,023,177    4,340,000
  • Take and Bake Business (Grocery Stores): ~18% of Revenue, growing
  • This is the company’s growth vertical. They started selling “take-n-bake” pizza to grocery store chains in September 2009. The Company has signed agreements for 1,206 grocery store locations to operate the take-n-bake pizza program and has opened take-n-bake pizza in approximately 945 of those locations.
  • Again, the company has essentially no costs associated with this segment as they are licensing their brand. The company develops distribution agreements with grocery store distributors, sign licensing agreements with Grocery distributor customers, and service them through foodservice distributors
    • This clearly only has value to the extent that customers “value” the Noble Roman’s brand
    • Given their profitability and growth in number of grocery stores (see below), the NROM brand clearly has value
      • It is likely that this value is geographically bound
2010 2011 2012
Grocery Stores operated 452 833 912

-The above numbers are only for operated stores. The number of “signed” stores is higher since there is a time delay between stores signed and operated. Still, the company has doubled the number of grocery stores operated from 2010 and this segment is now a significant driver of value.

  • A key question in the valuation is how many grocery stores NROM can sign/year and when the growth will stop. I asked Ian Cassel this question. He is very knowledgeable on the company and wrote a great article on them here:
    • He said, “I think they had 10 distributors at YE 2011, and now have 13. So the question would be how many grocery stores do these 13 distributors represent? When I talked to the company a few months back (when they had 11 distributors), I think they represented 4000-5000 stores. So this would be a good starting point for guestimation”
    • This is an important and difficult estimate in the valuation, but I think this is a reasonable way to frame the scenarios
    • This is clearly a growth segment that should have a long runway given the existing relationships with grocery distributors
  • Traditional Locations (~12% of revenue), has been in decline
2010 2011 2012
traditional locations revenue 1,460,709 1,368,883 922,000
  • The traditional franchise locations have struggled recently. However, one would expect the worst locations to close over time and eventually for the company to be left with only the best locations. In either case, it is best not to be too optimistic when valuing this segment going forward, but at 12% of revenue, it is not a huge value driver.

Other Valuation Considerations

  • In June 2008 the company was sued by former franchise owners for Fraud. In December of 2010, a court issued a summary judgment in favor of Noble Roman’s and all appeals were rejected. Noble Romans’ countered sued claiming the franchise owners had breached their contracts and owe substantial damages. $3.6M for damages and $1.4M for legal expenses
    • This claim has been granted summary judgment but the final amounts are pending.
    • It’s unclear how much, if any, of this will be recovered. However, this only represents upside (and considerable upside relative to the approximate $15 mm mkt cap)
  • Deferred Tax Assets
    • The company has over $9 mm in deferred tax assets that will keep it from paying taxes for ~4 years, a considerable source of value
  • The company has plans to franchise stand alone take-n-bake stores. “Papa Murphy’s” has been quite successful with these types of stores with over 1000 nationwide. The company seems excited about this initiative. I think it is too early and speculative to factor this into the model, but its success would obviously provide upside.

Valuation: Three Scenarios, 10-year DCF

  • I think the easiest way to approach this would typically be to look at the three segments. Non-traditional should be flat at worst, traditional location is going to continue to decline, and take-n-bake should grow. Given the current size of these segments, the overall effect should be net positive revenue growth. I think it is very hard to make a case to the contrary given how fast they are signing new grocery stores.
    • If we assume net positive revenue growth, then valuing them at a “no-growth” earnings power valuation should be conservative.
    • Taking estimated full year 2012 revenue of $7.46 mm and applying a 35% operating margin results in $2.61 mm. Normally, I would apply an ~40% tax rate to get to $1.56 mm in NOPAT, divide by a discount rate of ~10% to get to $15.60 mm in run rate earnings power value, subtract their $4.9 mm in debt and arrive at a value of ~$0.54/share.
      • However, because of the deferred tax assets, the 40% tax rate is not applicable for the first four years. Currently, EBIT = FCFF. However, looking at these unrealistically pessimistic assumptions shows the limited downside. Even in this scenario, downside is only 28%. That’s zero growth, no tax advantages, no legal payments, no benefit from new franchise concept. Now let’s look at a few more realistic scenarios that incorporate the tax advantages:
  • Worst Case: $.72 (-6%)
    • 0 grocery stores per year added
    • Flat non-traditional stores
    • Precipitous 35% decline in franchise stores
    • No legal payout
  • Base: $1.13 (46%)
    • 100 grocery stores added per year
    • Non-traditional stores growing at inflation (3%)
    • Franchise stores declining at 20% per year
    • $1M out of $5M in legal payout
  • Best: $1.67 (116%)
    • 400 grocery stores added per year
    • Non-traditional stores growing at inflation (3%)
    • Franchise stores staying flat
    • $4M out of $5M in legal payout

I think the base case of $1.13 is pretty conservative and that anything less is a real bargain.

Why does the opportunity exist?

  • The company trades for less than $1 and has a market cap < $20 mm
    • No research coverage, institutions prevented from buying
  • The company does not screen well
    • P/E > 20, which does not look cheap at all. However, on a Market Cap/Lev FCF basis it is extremely cheap at         ~8X with growing FCF.
      • This is due to the deferred tax assets that will prevent it from paying taxes for ~4 years
  • Company has been bogged down by frivolous lawsuits which have harmed results, threatened the existence of the company, and distracted management from growing their business
    • This is largely behind them and is now a potential catalyst (repayments) rather than a liability


  • This is not a sexy stock. It’s a pizza franchising company. However, the main source of revenue (non traditional franchises) is very sticky, there is a strong growth vertical (take n bake), and it has some very valuable deferred tax assets. Even assuming no growth in grocery stores/year, the stock has very limited downside. I think fair value is at least $1.13 and that this is a very low risk bet that should handily outperform the market for patient investors.

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Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.

Harvard vs. Einhorn: Chipotle Mexican Grill (CMG)

On September 24th-25th, I traveled to Ithaca, New York with two Harvard classmates, Linxi Wu and Jared Sleeper, to compete in the Cornell Undergraduate Stock Competition.

The Rules: There were six teams total, each comprised of three members. Teams from Harvard (us), Wharton, Cornell, MIT, Columbia, and Dartmouth were represented.

One week before the competition, we were given the stocks to analyze. For the first round, everyone had to analyze Chipotle (CMG). You could recommend a buy, hold, or short. Presentation time was 10 minutes with 5 minutes of Q&A from the judges from Fidelity and Putnam Investments. Three of the six teams would be selected to compete in the final round where each team was given a choice among four education stocks: DV, COCO, APOL, and BPI.

Our CMG pitch earned us a spot in the final round along with the teams from Wharton and Cornell. Our pitch on DV earned us first place overall in the competition with Wharton in 2nd and Cornell in 3rd.

I went in thinking we would probably go short CMG. After all, it’s a restaurant stock at 20X EBITDA and 40X earnings.. cmon right?! The inner value investor in me cringed at that type of valuation. However, as we really dug in every night and tried to understand the business and build out our valuation model, I really came away much more bullish on CMG with a price target of $406.50 (~45% undervalued).

Recently (and after our pitch), David Einhorn came out recommending a short of Chipotle based primarily on increasing competition from Taco Bell combined with its high valuation. Einhorn is one of my favorite investors (if not my favorite), but I was very surprised by his pitch. It honestly seemed so much less sophisticated than his excellent short call on Green Mountain Coffee (GMCR).

The GMCR short pitch was a 100+ page PowerPoint presentation focused on accounting issues that other investors were not properly accounting for. The CMG pitch is just: high valuation + increased competition from Taco Bell? Really?

High Valuation: I also thought 20X EBITDA was way too expensive… until I really dug into the numbers. CMG is less than halfway to reaching U.S. market saturation and I think they are likely to grow into their valuation over time. As you can see in the presentation and the model assumptions, 20X EBITDA is not always expensive. As we point out in our presentation, CMG was trading at an even higher P/E ration in 2006 (44.5X) and has returned 37.6% annually, crushing the market. Just looking at a single metric just doesn’t cut it for such a high growth company.

Taco Bell and their new Cantina Menu: Taco Bell has been around for decades and they are just now putting their emphasis on the Cantina Menu. Why? Because it’s not that great of an idea! If it was such an easy sell and market opportunity for them, this would have come out years ago. While it may have some success, I don’t think anyone is going to start confusing Taco Bell for Chipotle. When we analyzed this issue, we likened this to McDonald’s rolling out their McCafe coffee. Sure some people buy their coffee now from McDonald’s, but this has not cannibalized SBUX or their long-term prospects.

Here is the PowerPoint presentation for CMG:

I am a special situations oriented value investor, so high growth stocks like Chipotle normally don’t find a place in my portfolio. That being said, if I had to go long or short, I’d go long from these levels and I think going short is way too risky. Shorting a strong business is a loser’s game in my opinion. Even if you are right (which I don’t think Einhorn is here), momentum can kill you. Should be interesting to see how this plays out.

Here is the PowerPoint presentation for DV (there will be a separate post later).

Don’t forget to subscribe to my blog, like the Facebook page, and follow my Twitter for more updates!

Disclaimer: The content contained in this blog represents only the opinions of its author(s). I may hold long or short positions in securities mentioned in the blog. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. This blog is not a solicitation of business– the content herein is intended solely for the entertainment of the reader and the author.