Boring Portfolio

Bore To Sell Andrew Corp and Borders Group

by Dale Wettlaufer (

ALEXANDRIA, VA (Jan. 27, 1999) -- Ever see The Empire Strikes Back? Remember when the Imperial Cruiser dumps its garbage before it makes the jump into hyperspace? Well, we don't want to liken ourselves to something that's about to jump into hyperspace or any of our holdings to garbage, but we're definitely selling some stuff today. Here's a link to our sell report.

We took a pretty big hit today on Borders Group pre-announcing once again. Since my parents live in Buffalo, I've been aware that the snow up north has been bad. This didn't come as any surprise. But I'm not exactly into the slow death by torture thing. I made the decision to dump this stock because I think serious damage has been done to the company's economic model and I have no idea how vigorously Borders will defend its market position. We hope to have a good replacement for these funds in the very new future.

Along those lines, Costco (Nasdaq: COST) moved up, to our displeasure. I like this company a lot and look forward to the day when we can welcome it into the portfolio. Not that this move up disappoints us, but it removes $6 per share of margin of safety.

Another thing we'd like to look at is the movie theaters. On earnings, they look cheap at first glance, at least Carmike Cinemas (NYSE: CKE) does. They are also looking at a strong upgrade cycle, which will necessitate large cash outflows, but the most aggressive companies to build will win the best customers who are most inclined to spend money on more than just the movie ticket. Just an idea here. Nothing really that's been occupying our thinking.

Also, a friend of mine (who the above idea comes from) and I were talking about Art Samberg's discussions of value in the Barron's rountable. I hope you have access to the article, because I wholly agree with Samberg on value. There's no reason in the world that a PC manufacturer or AOL or even at the right price cannot be value stocks. You just need to buy them beneath their intrinsic value for them to qualify.

So, we're out there searching for value right now, though the environment is tougher today than it was six months ago. There is value out there, however.

On a different note, FelCor's (NYSE: FCH) CFO sent us a note today on our treatment of their financials. It was very kind of them to help us educate our readers on the REIT industry. I will concede that historical corporate return on equity (ROE) certainly understates an investor's ROE. However, for a company that retains all earnings, there is only one layer of taxes on the company's ROE, just as there is for a REIT. Granted, when the investor does sell, he incurs a capital gain if he has done things correctly. In all, though, I could have stated this better. I'm glad the company does think about after-tax return to investors, though.

Regarding the company's discussion of depreciation, funds from operations, and cash available for distribution (CAD), one note that we would have is the following:

When we said we don't believe in "FFO (funds from operations) mumbo jumbo," we meant the way the entire REIT industry goes about FFO. Maybe that's a little harsh on our part. We just don't agree with the institutionalization of a measure that includes return of capital as well as return on capital as the bottom line performance measure of an investment.

As we said in our analysis of the company, take what we say with a grain of salt. We're new to REITs and we don't understand them. Therefore, we don't want to be involved with them. One should never commit capital to an investment where one has little familiarity with the basic measures of performance or with the basic moving parts of the underlying company.

Apparently, REITsters look at CAD as somewhat analogous to net income and then look at CAD over shareholders' equity as a measure of return on capital. The line of reasoning goes that book depreciation overstates economic depreciation. I understand why depreciation would be accelerated for tax purposes, but not really for financial accounting purposes. For tax purposes, the higher depreciation, the more cash flow is sheltered from taxes.

However, if you want to say book depreciation overstates the true economic depreciation of the assets in question and you then present a CAD figure to represent the analog to net income, then you have to increase book value to get a truer return on investment. Book value would be increased by the accumulated amount of over-depreciation and the ROE analog would be calculated using CAD over the new, higher amount of owners' equity. The over-depreciation over the years contributes to a degraded book value for the purposes of calculating ROE, increasing return on capital, as presented in Mr. Churchey's note. You can't have it both ways. If you want to present ROE with less depreciation in the earnings analog, then you have to present a higher book value for the ROE analog. If you take less away from the assets, then you take less away from either liabilities or owners' equity or a combination of the two to balance both sides of the balance sheet. In this case, the accumulated depreciation above and beyond the economic depreciation would all be added back to both assets and shareholders' equity, reducing return on investment below Mr. Churchey's ROI presentation.

Here's a link to the entire presentation of FelCor's letter (in Word format), which includes tables on CAD and return on investment. (For a version of just the text of the letter, click here.)

We hope to see you on the boards, and be sure to also read the Boring Sell Report on Andrew Corp. and Borders Group.

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01/27/99 Close
Stock  Change    Bid
ANDW  -  1/8   17.88
BRKb  -9       2107.00
BGP   -3 1/8   17.13
CSL   -  7/8   46.44
CSCO  -3 11/16 103.44
PNR   -1 5/16  38.19
                   Day    Month   Year  History
        BORING   -3.73%  -4.50%  -4.50%  28.23%
        S&P:     -0.73%   1.14%   1.14% 106.71%
        NASDAQ:  -1.08%   9.78%   9.78% 131.24%

    Rec'd   #  Security     In At       Now    Change
  6/26/96  225 Cisco Syst    23.96    103.44   331.79%
  8/13/96  200 Carlisle C    26.32     46.44    76.40%
  2/28/96  400 Borders Gr    11.26     17.13    52.14%
 12/31/98    8 Berkshire   2244.00   2107.00    -6.11%
  4/14/98  100 Pentair       43.74     38.19   -12.70%
  1/21/98  200 Andrew Cor    26.09     17.88   -31.49%

    Rec'd   #  Security     In At     Value    Change
  6/26/96  225 Cisco Syst  5389.99  23273.44 $17883.45
  8/13/96  200 Carlisle C  5264.99   9287.50  $4022.51
  2/28/96  400 Borders Gr  4502.49   6850.00  $2347.51
  4/14/98  100 Pentair     4374.25   3818.75  -$555.50
 12/31/98    8 Berkshire  17952.00  16856.00 -$1096.00
  1/21/98  200 Andrew Cor  5218.00   3575.00 -$1643.00

                             CASH    $455.72
                            TOTAL  $64116.41