I am a glutton for punishment, and I will go ahead and predict that this is the lowest-rated write-up that doubles in the next three months.Hopefully you know the sordid story of Source Interlink, the company, and if not you can refer to my prior discussion.Here I want to focus on SORC, the stock, and why I think a highly-levered, consumer-focused domestic company will do well in this environment.Many of you will read this and turn away, but I ask you to consider my arguments carefully, and think a little outside the box.
Stocks are shares in cashflows of a company, but they are also options, with the strike price being the total debt.I would argue that SORC is an option that has many attractive features.
Attractive Optionality Part 1: SORC has 1.3b of debt and 52m shares.EBITDA for 2008 should be around 200m, growing to 250m as the company executes.The original thesis revolved around this company being comprised of mostly media assets, which should get 8-12x multiples, depending on the market.Every multiple point of expansion is $5 per share on the stock price. Say what you will, but the company has executed pretty well for the last 3 quarters and has not gotten credit for it. The equity currently trades for 2x FCF.
Attractive Optionality Part 2:Ron Burkle has recently increased his position from 30% to 40% through open market purchases, at around $2.This is $9m of cash, not a small sum.If you believe that he has effectively backstopped the stock at $2, then the risk reward here becomes truly excellent.
Attractive Optionality Part 3: The debt on the balance sheet is mid-2007 vintage.That means things like covenants and cash interest are not around.The valuation impact that has on the equity is difficult to quantify, but if the banks cannot force the company into chapter 11 until the proverbial fan is quite dirty, then the expiration date of the option is much longer than in other, levered, situations.
Attractive Optionality Part 4: I have recently heard several (new) rumors of Burkle trying to add new magazines to his portfolio bolsters the argument that this company is his vehicle to consolidate the industry.Each title he adds raises the possibility of significant cost reductions and other synergies.
Attractive Optionality Part 5: I have also recently heard that investor relations is calling large equity holders and asking them for advice on how to start marketing the company.Evidently, they are quite pleased with how things are going and think this is the right time to hit the road.Take that for what it is worth.
Attractive Optionality Part 6: I hate people who use short squeezes as the reason to buy something.But do the math:Burkle owns 22m shares, and the I can count four more funds that I am pretty sure are long-term holders that total 15m.that leaves 15m shares that is in the true “float”.There are 14.5m shares currently sold short, so roughly 100% of the float.
IF I AM SHORT THIS STOCK, AND BELIEVE THAT BURKLE WILL KEEP BUYING SHARES AT $2, AND THAT IF THIS MANAGEMENT TEAM EXECUTES THEN THE STOCK COULD GO TO $5 OR $10 OR $20, DO I LIKE MY RISK/REWARD HERE?DO I REALLY WANT TO STAY SHORT?