Mittleman Brothers Investment Management commentary for the third quarter ended September 30, 2016. Does not mention Carson Block of Muddy Waters but is obvious – see below full letter.
Mittleman Brothers Investment Management, LLC ’s composite gained 10.8% net of fees in the third quarter of 2016, versus advances of 3.9% in the S&P 500 Total Return Index and 9.1% in the Russell 2000 Total Return Index. Longer-term results for our composite through 9/30/16 are presented below:
Mittleman Brothers – Portfolio Review
The top three contributors to our Q3 2016 performance were Revlon (REV): $32.18 to $36.78 (+14.3%). Carmike Cinemas (CKEC): $30.12 to $32.69 (+85%). and International Game Technology (IGT): $18.74 to $24.38 (+31.2% with dividend). The larger percentage gain from IGT was less impactful than the smaller percentage gains from Revlon and Carmike because those stocks had much larger portfolio position weightings than IGT.
The three most impactful detractors from our Q3 2016 performance were Rallye SA (RAL FP): $17.24 to $16.39 (-4.9%). First Pacific Company Ltd. (142 HK): $0.72 to $0.71 (-0.35% with dividend). and ABS-CBN Holdings Corp. (ABSP PM): $1.01 to $1.01 (unchanged).
We discussed Revlon in our Q1 2016 Investment Review. when it was the top performer. and again in the Q2 2016 letter when it was down for that quarter in our basket of deplorables. So rather than rehash the story here yet again. suffice it to say that the business seems to be trending well under new CEO. Fabian Garcia, formerly of Colgate-Palmolive, with innovative new product launches noticeable in stores recently. And the stock remains extremely undervalued. We estimate $78.50 per share is a fair appraisal of intrinsic value per share. which is 113% higher than the quarter-end price of $36.78. Revlon. at 9.1x EBITDA at quarter-end. would be 13.5x EBITDA ($50oM estimated for 2017) at our estimate of fair value. and still below the valuations of its larger peers such as L’Oreal (OR FP € 168.10) at 14.5x EBITDA. Estee Lauder (EL $88.56) at 13.7X. and Coty (COTY $23.50) at 14.5x. Revlon’s EBITDA margin. recently about 19.5%. should drop in 2017 to 17.3%, due to their recently closed $923M acquisition of the much less profitable Elizabeth Arden. but that metric should rebound in the ensuing years as the anticipated long-term synergies in that merger are realized. EBITDA margins for their peers are: L’Oreal: 21.2%. Estee Lauder: 19.8%. and Coty at 17.5% most recently. So Revlon’s profitability should not stand in the way of it attaining a valuation multiple much closer to the industry average. especially since the company has been growing faster than their larger peers over the past five years. mainly through acquisitions. but. importantly, with market share gains as well.
Our second biggest contributor to Q3 2016 performance, Carmike Cinemas, rose 8.5% during the quarter on the news released July 25th that AMC Entertainment had raised its offer to buy Carmike by 10.2% from $30 per share in cash to $33.06 per share in cash. or 1.0819 shares of AMC stock. but prorated such that no more than 30% of the total consideration paid will be in AMC stock (issuance fixed at $30.56 per AMC‘ share). As you know, we vocally opposed the first iteration of this deal. announced on March 3, 2016. which would have cashed us out of Carmike’s stock completely at only $30 per share. That we were able to garner enough support from other large shareholders and the major proxy voting advisory firms to effectively vote down that original deal is moderately satisfying. but the terms ofthis improved offer. while substantially better due to the AMC stock component introduced, are still well below the $40 per share minimum value we think represents the lowest price acceptable in a change of control situation such as this one. We continue to reach out to other large shareholders, explaining our ongoing opposition to this transaction, despite the improved terms, in hopes of encouraging other shareholders to vote against this unfairly undervalued takeover. As we pointed out in our Q2 Investment Review. at $33.06 per share AMC would be paying only 5.3x EBITDA post-synergies to acquire CKEC. the 4th largest theater chain in the U.S., and thus making the combined AMC/CKEC the number one chain in the country. This is especially galling since in mid-July AMC announced the acquisition of an almost identically sized theater chain based in the UK. called Odeon-UCI. for a 9.ox EBITDA multiple post-synergies. for a businesses that is substantially less profitable than CKEC (EBITDA margin of only 14.6% versus CKEC’s 16.8%). Usually when #2 buys #4 to become a new #1 there is a substantial premium paid in terms of valuation. and those deals don’t provide such massive accretion to the buyer in year one. We’ve previously noted that B. Riley & C 0. has claimed AMC ’s buyout of CKEC would be accretive to AMC‘ even if they paid into the mid $4os for CKEC‘. More recently FBR Co. issued a report on October 1oth estimating that on the improved bid, AMC would still create over $7 per AMC share in value from closing the CKEC buyout on these terms. That is $682M in value accretion on a deal costing them $1.2B. which is a huge amount of value accretion that should be more equitably shared with CKEC’s shareholders. The vote will occur at a shareholder meeting on November 15th. We are aware that one of the other largest shareholders of CKEC has changed their vote from “against” to “in favor” based on the modestly improved terms. and one of the two largest proxy advisory firms. 188. also changed their recommendation from “against” to “in favor,” mainly citing the improved terms. So with diminished support for our opposition, we must acknowledge the probability is much higher now that C armike will have enough votes to close the deal on November 15th. If that happens. we plan to hold on to the AMC stock we’ll receive for our CKEC‘ shares. as we believe AMC is also worth about $40 at fair value (versus $31.09 on O9.«””30.«””16), in which case the total consideration of cash and AMC stock we’d receive for our CKEC shares would be valued just over $36 per CKEC share. Not nearly enough to be considered fair. but certainly better than $30.
International Game Technology, our third biggest contributor to Q3 2016 performance was up 31.2% including a dividend payment, as investors finally seem to be waking up to the magnitude of the valuation aberration that has long plagued this high quality cash flow machine. The largest lottery systems management business globally, and the largest slot machine company in the world; investors seemed to have been overly pessimistic about the weakness in their slot machine business, while ignoring the strength in their lotteries business. We think this high-margin (36% EBITDA margin) highly recession-resistant business should trade at no less than 8x EBITDA ($1.83B estimated for 2017) and 14x FCF ($50oM in normalized Free Cash Flow in 2017), which would put the stock at $34.25, up another 40% from the quarter-end price of $24.38, not including