Summary. AMF is essentially a publicly-traded, management-led LBO (3.8x leverage, 3.0x coverage) with stable cash flows trading at 4.7x management's projected 2002 after-tax free cash flow per share. Management's latest projections can be found in AMF's Disclosure Statement filed in November 2001.
Description. AMF is the largest owner or operator of bowling centers with 400 locations in the United States and 117 overseas. The US centers produce stable cash flows as do the foreign centers on a local currency basis. This quality attracted Goldman Sachs to take AMF private in 1996. Unfortunately, the other attraction was the growth of AMF's products division, a manufacturer of bowling center equipment such as automatic pinspotters accounting for approximately 40% of the world's installed base. The Asian crisis caused the products division's EBITDA to fall from $70 million in 1997 to $8m in 1999. Roland Smith, who was credited with leading Triarc's turnaround of Arby's, was brought in as the new CEO, and AMF filed for bankruptcy protection in July 2001. AMF just emerged from bankruptcy with a consensual plan agreed upon in late February 2002, after nearly cramming down a reorganization plan on unsecured creditors.
The bankruptcy process created an incentive for the management team and the secured lenders, who were to receive substantially all of the reorganized equity, to hide value. Management wanted a low valuation because they were to receive warrants for 1.6 million shares with the exercise price based on the reorganization plan's valuation ($21.19 per share). The unsecured creditors vigorously objected, as one would expect, to Blackstone's $665 million valuation-based on management's projections-which was just enough to pay the banks nearly in full and leave almost nothing for the unsecureds. This under-valuation suited the secured creditors because they would receive nearly all of the remaining equity. The secured creditors provided the company's DIP financing and agreed to convert a large portion of their claims to equity, leaving reorganized AMF only modestly leveraged.
Aiding AMF was the concept of "fresh start" accounting, an AICPA methodology for companies emerging from bankruptcy. Under fresh start accounting, a company allocates its new reorganization value to its various assets as in purchase accounting. Allocating value to depreciable assets like PP&E is, of course, the preferred approach, so companies may stretch to write assets up. AMF, with 517 equipment-filled centers, had a lot of depreciable assets to which to allocate value. More depreciation also makes a company looks less profitable, which would not have upset either the secured creditors or management.
New AMF has 10 million shares outstanding now trading when-issued for approximately $19. Debt is approximately $450 million, comprised of a $300 million Deutsche Bank facility and $150 million of 13% notes (now trading over 103 and worthy of separate consideration). Total enterprise value is $640 million. Latest twelve month EBITDA through February 2002 exceeded $118 million. According to Moody's release of February 15, 2002, AMF expects nearly $12 million in savings from exiting unprofitable foreign locations and from restructuring its products division. The company's possibly conservative projections indicate 2002 EBITDA of $127 million, of which only $6 million is from products.
Upon emergence from Chapter 11, AMF adopted fresh start accounting. The most significant effect of this accounting approach is an inflated fixed asset carrying cost and equally inflated depreciation expense. In AMF's case, depreciation expense is more than 2x historical and projected capital expenditure levels. As a check as to whether these capital expenditure levels are unusually low, one can look at Bowl America, the only other publicly-traded bowling center operator, for comparison. AMF actually spends more per center than Bowl America. Bowl America spends approximately $1,200 per lane or $45,000 per bowling center annually on capital expenditures. AMF's capital expenditures in 2001 and their projections for 2002 are more than 1.5x this amount. Moreover, all of AMF's centers have been retrofitted for Xtreme bowling and updated with state-of-the-art scoring systems. The key, then, is to look at net income plus depreciation minus capital expenditures, which will be $40 million in 2002 according to the company's projections, or $4.02 per share (4.7x). A downside case might assume no EBITDA contribution from the products division, which would result in free cash flow per share of $3.43 (5.5x). An upside case might assume no growth other than the $12 million in savings, which would result in free cash flow per share of $5.22 (3.6x). By any absolute standard, shares at these levels are inexpensive.
Bowling is not a glamorous growth story, but AMF has demonstrated for years that bowling centers are a cash cow. The recession and the events of September 11th have not materially affected interest in bowling. This is a relatively unknown value investment opportunity that should show substantial capital appreciation once the investment community recognizes its free cash flow attributes.
Catalysts. AMF's substantial under-valuation, with estimated 2002 after-tax free cash flow of $4.02-$5.22 per share relative to its $19 stock price, should be recognized by the investment community, particularly when Wall Street analytical coverage begins. Management is strongly motivated to increase the share price, with 1.6 million options (11% of fully-diluted shares) at $21.19 and the board, with respected value investors like Farallon and Angelo, Gordon, should make sure that free cash flow is put to best use. A possible NASDAQ listing would also serve to catalyze the stock. In addition, meaningful improvements in the products division, while not necessary for the investment to work, could provide substantial upside.