In honor of Thanksgiving, I’ve decided to write about my biggest turkey, Aurora Foods. Aurora Foods was born of private equity cobbling together a bunch of orphan brands from major food manufacturers and loading them up with debt. Brands you probably have in your pantry: Duncan Hines, Lenders Bagels, Van De Kamp, Mrs. Paul’s, Celeste Pizza, Aunt Jemima Frozen Breakfasts, and several others. I first bought it when it was trading at a reasonable P/E and had shown good numbers.

My timing was impeccable. The very next day, the stock was halted and it was announced that earnings would be delayed. When the stock next traded, it was down 70%. So I bought more. It soon came out that management had committed a massive accounting fraud and they later went to prison. I kept holding though, and even buying more as it dropped further, believing that new management could revive these once-proud brands. I even got more shares and cash as part of a class-action settlement. I still have the worthless stock certificate I received as a reminder of my foolishness.

New management was indeed able to get the company back to profitability for one quarter. It was enough to get them their bonuses that year, and I was able to sell a little at a profit thanks to the runup. The company would never report a profit again and soon thereafter entered bankruptcy and my investment disappeared with it. The prepackaged bankruptcy merged Aurora into some castoff brands from Campbell to form Pinnacle Food Corporation.

I learned several valuable lessons. Big companies rarely sell brands that can easily be “fixed” unless forced to because of antitrust concerns. If Procter & Gamble’s marketing whizzes and ample capital can’t fix it, Joe’s Overleveraged House Of Dead Brands probably can’t either. If an IPO is happening and somebody other than the company is getting the bulk of the proceeds, stockholders will more than likely be left holding the bag. And what goes down doesn’t always go back up.

What was your biggest turkey? What did you learn from it?

I previously wrote about BJ’S Wholesale(BJ) in September when the stock was at $26. Since then, the stock has slowly crept up prior today’s leap which has had it trading as high as $32. Today’s jump comes after the company announced that CEO Mike Wedge would be retiring. Reading the press release further gives additional color to the circumstances of Wedge’s departure:

In a joint statement, Messrs. Wedge and Zarkin stated, “While the Company has made great strides in its efforts to improve general merchandise sales and customer traffic, overall progress has not come as quickly as we had hoped and expected. We agree that the Company’s leadership team will benefit from a fresh perspective at this time.”

Mr. Wedge was replaced as CEO by 68 year old Chairman of the Board Herb Zarkin, who will serve in an interim role as replacement is found. Based on the positive move upwards, the market appears to think that longstanding rumors that BJ’s will be acquired will come to pass. The company looks like an attractive target for private equity as it has no long term debt and owns substantial real estate.

On the other hand, Mr. Wedge’s departure raises troubling questions about the company’s performance. Same store sales have been lackluster of late, but last week’s earnings announcement was ahead of expectations and management expressed optimism regarding Q4.

I have a sinking feeling that another shoe may drop before a buyer comes along. Given the 25% runup in the past 2 months, now looks like a good time to follow Mr. Wedge out the door and say goodbye to BJ’s

Disclosure: I have a position in BJ

US Air(LCC) announced this morning that it plans to buy Delta(DALRQ). My friend at Flight Wisdom has a fine post summarizing the details, but the stock movements are a bit mystifying to me.

US Air is up 12.5% now, down a bit from its high of the day, but still a substantial jump. Clearly investors applaud the idea of an US Air-Delta combination. But there are many hurdles to such a deal. First, neither Delta nor the creditors have agreed to anything, Second, there are rumors that other buyers have expressed interest. Third, bankruptcy is a complicated process and there are no assurances that anything will happen. US Air has soared on vapor, and is likely to pull back as investors have a chance to reflect.

Delta’s movement is even more strange. Delta stock is also up over 10%, driven up by buyers excited at the prospect of an acquisition. Yet, there is almost no chance that Delta stock will have any value post bankruptcy. The creditors own the company. Game over for the stockholders. Period.

It’s strange to see this new era of speculation in airlines. Warren Buffett said in his 1992 letter to shareholders:

Investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Buffett later fomusly quipped that had he been there, he would have shot Orville down as a public service. Of course it’s possible to make money in airlines. But extreme caution would be prudent.

Disclosure: I hold no position in LCC or DARLQ

In 1947, Bing Crosby, unhappy with the necessity of performing his radio broadcasts live, invested in a small company developing recording technology of sufficient quality to allow him to prerecord his show. It would prove a shrewd investment as not only was Crosby able to record his show ahead of time, but Ampex(AMPX) grew to dominate recording for the broadcast industry, not just for audio but for video as well.

Like many American icons, Ampex faded as new technologies supplanted its core products, and attempts to move in new directions were unsuccessful. By late 2003, Ampex’s stock was below $1 and it was delisted from the American Stock Exchange.

Then came Act II. Ampex began asserting some of the many patents it owned covering various aspects of digital photography and struck several licensing deals including one with Sony that paid it $40 million. The stock zoomed upward, topping $50 in 2005. It has since dropped back to its November 13th close of $14.15, still far above its 2003 lows.

Despite early success with patent licensing, questions linger. A patent responsible for much of the licensing revenue expired in April 2006, and the company lost a key patent case to Kodak. The company has begun to derive revenue from additional patents, and still sells high-end data storage systems, but with its heavy debt load and pension obligations it has been unable to regularly report a profit. Although it did report a profit in its most recent quarter, this was only because of a large one-time gain relating to a deal involving another company once controlled by its CEO.

It’s difficult for me to assess the value here. While the company still has a large array of active patents, they are not easily valued. At least one large shareholder feels there is significant value though. After the close on November 13, ValueVest High Concentration Master Fund filed a 13D disclosing an 8.3% stake in Ampex. In addition, ValueVest disclosed that in February it had hired an intellectual property firm to help it evaluate Ampex’s IP. As a result of the evaluation, ValueVest contacted and met with management several times beginning in May, and offered to acquire additional equity through a strategic investment.

On September 15, ValueVest upped the ante:

the Investment Manager once again confirmed the Master Fund’s interest in acquiring or making a further equity investment in the Issuer. In that letter, the Investment Manager also indicated that it would like to discuss an alternative transaction in which the Master Fund would acquire the Issuer’s Data Systems business and all of its intangible assets other than those patents which the Issuer was currently licensing or litigating and their related patent families. The Investment Manager indicated that it believed that this alternate asset transaction, which would not be subject to any financing contingency or condition, could be implemented relatively quickly and would give the Issuer the opportunity to realize immediate value for its shareholders and to generate further shareholder value through its ongoing patent licensing and litigation efforts.

On September 15, the company responded that the matter would be discussed at Ampex’s next board meeting in early November. ValueVest filed its 13D having still not received a response from the company. During this time, ValueVest has continued to purchase shares, over 130,000 since the beginning of November.

If the company’s patents can be successfully licensed, it stands to bring in a great deal of money. The company owns patents which may cover digital still and digital video cameras, cell phone cameras, DVD recorders, DVRs, and other similar devices. In the shorter term, ValueVest’s agitiation could raise the stock price, but I’d be cautious given the runup over the last week as ValueVest has acquired shares.

List of Ampex patents

Disclosure: I hold no position in AMPX

As I am a bit of a curmudgeon, one of the highlights of my weekend is picking Barron’s up off my front steps and reading the column by master curmudgeon Alan Abelson. Mr. Ableson’s prolonged absence earlier this year had me quite concerned and since his return, I have read with a new appreciation. Also, and this is a completely superfluous bit of name-dropping, Mr. Abelson and I went to the same high school. Of course, being a half century apart, I never met him, though I suppose we’d belong to the same alumini association if I ever bothered to pay my dues. Not only that, but at my graduation, they picked the other long-time columnist alumnus with the same initials to speak.
I was particularly pleased to see another investor referred to as “inelegant” in Abelson’s column this week. Abelson quotes from the latest quarterly letter from famed investor Jeremy Grantham. Grantham is the founder of GMO and his commentary is available at gmo.com after free registration.

In his most recent letter, Grantham has a wonderful piece continuing a previous discussion on the shortcomings of volatility as a measure of risk. In his previous piece, he described how

In the long term, volatility seriously overstates the risk of equity ownership because it ignores the strongly mean-reverting tendencies of both economic fundamentals and the stock market. That is to say, bad times fairly reliably follow very good times, and vice versa. Conversely, in the short term, volatility, at least as typically used, tends to understate risk by underestimating both the extreme nature of short-term outliers in real life and the occurrences of extreme events not hitherto experienced.

In his latest missive, Grantham provides data which demonstrates that low beta stocks have consistently outperformed high beta stocks. He then explains what might be the cause of this counterintuitive conclusion. Grantham posits that growth stocks have lower “career risk” and illustrates what he means with an anecdote:

In our earlier years at Batterymarch, the investment firm that Dick Mayo and I co-founded with Dean LeBaron, we lost 50% in the 1973-74 decline (almost identical to the losses of the big banks with their Nifty Fifty stocks). But we lost far more business and nearly failed because, as one client brilliantly put it, we lost our 50% ‘inelegantly.’ Great Lakes Dock and Dredge, Hartford Steam Boiler, and Twin Disc Clutch made clients feel much worse, apparently, than losing the same money in Avon, IBM, and Johnson & Johnson. It is my opinion that this is one of the central truths of the investment business. Stocks and assets that make investors feel uncomfortable even if they are less risky will always have to return more than appealing, currently successful, and exciting companies. Owning the latter, and explaining why you do, is simply a better business proposition.

Fortunately for me, I have no clients to please, but the temptation of “exciting” stocks still takes work to avoid. Inelegant investing isn’t always easy, but I’ll continue to prefer higher long term returns to short term thrills.

Analyzing a stock is reading a tale of two companies and deciding whether it’s the spring of hope or the winter of despair. Blair Corporation(BL) initially caught my attention because it has no debt and trades close to its book value. Blair has a market cap of only $120 million, and its 3.8% yield looked quite attractive. Further investigation yielded the other story, the tale that explains the modest valuation.
Blair began in 1910 as a direct marketer of raincoats. The company has expanded and is a direct marketer of women’s clothing, men’s clothing and home fashions. Blair began the decade with big hopes. John Zawacki was promoted from head of women’s wear to CEO at the end of 1999, and announced ambitious plans to grow the company from its 1999 sales level of $522 million to over $1 billion by the end of the decade. In 2000, Zawacki described the company’s problem to Multichannel Merchant:

The Blair customer file has been aging for some time,” says John Zawacki, Blair’s president/CEO, who took over for Murray McComas in January. “In 1965, the average age of the Blair customer was 47; today it’s 65. We realized we had to find a way to bring that younger demographic into the fold.

To try to grow the business and move into a younger demographic, Zawacki launched the Crossing Pointe catalog, signing Jane Seymour to brand a clothing line. Crossing Pointe never gained real traction and was shut down by the company in 2005. Other attempts at starting new product lines such as a wholesale outerwear business called Allegheny Trail failed as well and were shut down.

By 2003, Zawacki had managed to grow revenues only 10%, and they would peak there at $582 million. Since then, they have fallen precipitously to only $456 million in 2005 and only $307 million in the first nine months of 2006. One thing that the company had going for it through the first half of the decade was consistent profitability. This derived largely from the company’s profitable financing division. In 2005, under pressure from activist investors, the company sold its financing arm and used the proceeds to buyback more than half of its outstanding shares at $42 per share. Since the completion of the tender offer, the stock has fallen to the low 30s as Blair has been unable to show a profit.

As the company’s revenue has plunged, it has not been able to cut costs fast enough to keep up. While it has done an excellent job of improving sourcing as cost of sales has dropped from 47.4% of total sales in 2003 to 45.4% in 2006, both advertising and G&A have surged as a percentage of net sales. Advertising has gone from 26.9% of total sales in 2003 to 30% in the first 9 months of 2006, and G&A from 23.4% to 29.1%.
Fortunately, the company’s losses aren’t too great. An improvement of a few percent on any of these items would swing the company to a profit, and in fact it showed a modest one in the Q2 2006. Unfortunately, there’s no reason to think that current management is capable of this.

Ultimately, this company needs to fix its fundamental problem. Its current business is declining as customers age, no new business is taking its place, and its fixed costs remain high. I believe that this will eventually combine in some fashion with other catalog/internet retailers so that its exisiting infrastructure could be used more fully. As far as I can tell, the company has never completed an acquistion. My bet is that the company is acquired either by a strategic buyer(IACI could be a good fit) or private equity. I might consider buying some if it fell back near its low of $23.73, but at yesterday’s close of $31.50, it’s too rich for me.
Disclosure: I own none of the stocks mentioned