The goal of every value investor is to buy a dollar for 40 cents. It turns out that it's also the goal of rapper 50 Cent.
The New York Post reported on Sunday that the cash-rich superstar purchased an 18-bedroom Connecticut mansion for $4.1 million from the ex-wife of financially distressed boxer Mike Tyson. The market price in 1999: $12.9 million.
Tyson, who filed for bankruptcy late this summer, purchased the property in 1996 for $2.7 million, adding a 1,000-person night club and a 1,500-square-foot-gym. The next year, he put the property -- which also has a racquetball court, seven kitchens, a theater, an elevator, and a waterfall -- on the market for $25 million.
But as he blew $300 million in earnings, Tyson lowered the price to $22 million and then to $12.9 million. He eventually turned the property over to his ex-wife, Monica Turner Tyson, for $1 after a divorce proceeding. She then sold it to 50 Cent for $4.1 million.
So how does an investor take advantage of this kind of scenario? By knowing that a good, cash-rich business can create value where a bad business fails.
Level 3 Communications (NASDAQ:LVLT), for example, owns an all-IP network that runs gross margins upwards of 70% to 80% -- roughly twice the margins of the next most efficient network. Last year, the company purchased Genuity -- its cash-bleeding rival that once had a market value measured in billions -- for less than a quarter of a billion dollars. As part of the deal, Genuity declared bankruptcy, and shareholders were left holding worthless shares.
Since then, Level 3 has taken Genuity's revenues and migrated them onto its more efficient network, while eliminating some of Genuity's overhead. The long-term effect is that Level 3 may have created a viable business out of lemon. So where the assets may be worth $0.40 to Genuity in a sale, they may be worth $1 to Level 3.
Harrah's Entertainment (NYSE:HET), on the other hand, can gain value in a debt-heavy gaming industry simply because it can borrow for less than anybody else. The company, which in recent years has purchased Player's, Harvey's, Rio, and Horseshoe Gaming, can acquire assets and simply refinance the debt of the companies it acquires. In that way, Harrah's can pay a premium and still gain $0.04 to $0.05 on the acquisition dollar before reaping the benefits of operating synergies.
The lessons here:
- If a business is a lemon, stay away from it no matter how cheap it is. In other words, don't invest in Mike Tyson, no matter the price.
- Cost of revenue and cost of capital may represent powerful competitive advantages.
- Cash is king.
Jeff Hwang owns shares of Level 3 Communications.
