Activist Play: PBY

**FutureHFGuy** Fri Apr 21, 2006 5:48 pm

Activist Play: PBY
Pep Boys is a national aftermarket retail and service chain that serves all four segments of the automotive aftermarket – do-it-yourself, do-it-for-me, buy-for-resale, and replacement tires. According to the company’s website Pep Boys currently operates 595 stores in 36 states. Their “prototypical supercenter” is 18,200 square feet with 12 state-of-the-art service bays. For more company information: http://www.pepboys.com/about/company_info/fact_sheet.html

Several significant developments have unfolded in the last month. On March 28 James Mitarotonda of Barington wrote a letter to the Chairman of the Board, saying they “have no choice but to seek representation on the Pep Boys Board.” Then on April 20, Pirate Capital filed a somewhat brutal 13D grilling everyone from the board to the CEO (Lawrence Stevenson). The immediate implications are that Barington is going to nominate a slate of directors for election at the next annual meeting. Pirate wholeheartedly supports Barington’s actions according to their 13D as they “currently anticipate voting in favor of the Barington slate of nominees at the 2006 annual meeting.”

According to the filing, Pirate bought their shares between $14 and $15.05. Pirate believes “the Board of Directors…has overseen the destruction of significant shareholder value, and…the continued support of Lawrence Stevenson…is unwarranted.” Furthermore, Pirate characterizes Stevenson’s efforts as “a failure”. Why is Pirate so anti-management? Largely because Stevenson’s turnaround plan (beginning in 2003) has been largely ineffective.

Additionally, Pirate gave a huge hint that this company is going to have the opportunity to be purchased. Pirate believes that “in the near future the Board will have the opportunity to make an important decision to maximize the value of the Issuer, and [we] encourage the Board at that time to sell the Issuer.”

This doesn’t come as a surprise, however, to any studious reader of 13Ds. Why? Because Barington (in their first 13D filing) stated, “[We] desire to engage in discussions with the independent members of the Board of Directors of the Company concerning measures … that will improve shareholder value for the benefit of the Company’s stockholders, including … the employment of a new Chief Executive Officer and the appointment of an independent Chairman of the Board of Directors; and strategic alternatives to maximize the value of the Company's automotive service center business and reduce the indebtedness of the Company.”

PBY might not look like a value stock after a quick glance, because of; negative “earnings”, significant long term debt, falling operating margins and awful returns on equity. I believe all of these points are insignificant for the following reasons;
the company is producing positive operating cash flow, which is more important than reported “earnings.” $1.05 per share in 2005 PBY produced $1.05 per share, according to Value Line, and I think the company should do $1.55-$1.65 in operating cash flow per share in 2006. The company’s long-term debt, though significant at $390 million, only costs $35 million per year to service that can be covered more than 2x over with TTM EBITDA. Although the company’s operating margins fell to 3.5% in 2005, Value Line expects this to return to 5.5% in 2006 and continue to increase to 7.5% in the next 3-5 years. The company’s negative ROE in 2005 is certainly atrocious, especially when compared to 5.5-7.5% over the last three years. However, this number should return to being positive this year. Also, this number should return to 7-9% within the next 3-5 years, according to Value Line.

I believe that this company should trade for 9-11x forward operating cash flow. Why forward? Because this company is currently in the middle innings of its turnaround I don’t believe current performance figures represent the true performance potential. I believe this company is easily capable of doing $2.25 in normalized operating cash flow per share once the turnaround finally takes hold. Assuming that conservative figure, this company is worth $20-$25 per share, excluding the significant real estate value.

**goog** Mon Apr 24, 2006 1:57 pm

from http://finance.yahoo.com/q/cf?s=PBY, the cash flow in these several quaters are not good. Did you check sec filing to verify the valueline data?