One of my favorite pieces of investing from Michael Price

Michael Price is a legendary investor and someone I try to learn from whenever I get the chance. I mean, this is one the guys that taught Seth Klarman how to invest capital. A few years ago, Michael Price gave a speech to Bruce Greenwald's Value Investing course at Columbia Business School. While I do not have the transcript directly in front of me, his words can be summarized as follows: "Read proxies and bankruptcy disclosure statements because they tell you what rational buyers are paying for businesses."

Now this is not theoretical data - i.e. this stock should trade at 6x or 9x - this is a real buyer, with real capital at risk, deploying that capital to buy a certain asset or company. And that information holds value and is very rarely discussed or even analyzed by the sell side.

For those that are interested on Bloomberg, you can make a macro to type in NSE "PREM14 A", and assign that macro to a button and have all the proxies filed at the tip on your hand. For disclosure statements, the process gets a little trickier - you have to monitor the docket to determine when the disclosure statement actually gets filed.

To be sure, many times this information needs to be sensitized relative to company specific factors. For example, I think it would be ludicrous to use most on the run proxy statements to value a distressed company in the same industry. Or if a company is heavily capital intensive versus an asset light company in the same industry - those companies should trade at different multiples because of the ability of the asset light company to better translate EBITDA into real tangible free cash flow. Make sure you are comparing apples to apples here.

Let's take a real world example: On Friday, Great Atlantic said it may file bankruptcy as soon as this weekend. Great Atlantic is always a hot topic among distressed investors. I know many people that bought near dated puts on the company thinking that any rescue effort would fall short. Seemingly it has. Rumors were swirling around the market on Thursday with bonds down 4 or 5 points on the session and then dropping further on Friday.

In January of this year, Penn Traffic, a regional grocer that has filed three times in the past ten years, sold substantially all its assets for $85M to Tops Markets. Here is the disclosure statement: Penn Traffic 2nd Disclosure Statement. According to the Affidavite of the Chief Restructuring Officer:

"Tops proposed a multifaceted transaction pursuant to which it would acquire a substantial number of stores as going concerns with commitments to employ the unionized workers at those stores, act as the Debtors’ liquidation agent with respect to underperforming stores to conduct going out of business sales and liquidate the merchandise in the Debtors’ closing stores, extinguish approximately $72 million of prepetition withdrawal liability claims which otherwise would have been asserted by one of the Debtors’ multi-employer pension funds, and consensually reduce by approximately $27 million the claim of the Debtors’ largest supplier."

Using $85M, and the 2009 financials, this represented ~0.1x revenue, 7.7x adjusted EBITDA. What does this mean for GAP?

• LTM Revenue is ~$8.5B. Using PTFC's multiple gets you to $850M valuation
• LTM EBITDA is $100M. Using PTFC's multiple gets you to $770M

***Note - I have edited this section for an error I made last night - score it at "Error - Lack of Sleep" for viewers at home***

But this is where things get tricky. GAP has talked about in previous conference calls there is a $100M cash flow loss from dark store rent. Seemingly in a bankruptcy they could get rid of these leases. There is ~$130M available outstanding on the term loan, ~$140M in cap leases, as well as a plethora of other claims: Long term real estate liabilities, pensions, etc.

Where does this leave us on our $260M of the 11.375% notes. Normalized EBITDA is probably somewhere between $150-$200M after adding back the lease losses. Using $150M and 7.7x multiple gets you to $1.15B in value. Less $130M in term loans, $140M in cap leases gets you to about $900M in value. But given how fast a grocer turns over its inventory as well as a large number of LOCs on the balance sheet, I believe a DIP here will be fairly substantial. For the last 4 years, accounts payable at the 4th quarter is around $200M, so I'll use that. We then have to add in admin expenses. I generally model 2-5% of total debt outstanding depending on the complexity of the case - I'll use 3.5% here which is another $50M of claims.

We are down to $650M in value versus our 11.375% notes. This leads me to believe these bonds are the place to play in the structure - I wish they were lower, but at 80 cents on the dollar, you are getting a decent (albeit possible inadequate) margin of safety here. Other reasons: The 2nd lien notes are guaranteed by the operating subs whereas all other debt (other than credit facility) is not. The bank debt looks to be money good here and seemingly the 11.375% quotes will be the fulcrum security.

We know we have any interested party here: Yucaipa is deeply involved here. Do they step up to take out the fulcrum security to gain control of GAP once and for all? Other things that keep me interested in this case: GAP has a number of brands they could sell to interested parties. While food deflation is all the rage among grocers, I believe this a temporary phenomenon. An investment in GAP's second lien notes may be one of the cheapest ways to play a wave of food inflation over the next few years. And remember, a rational buyer bought similar assets just 10 months ago at the 7.7x valuation - call them crazy if you think I shouldn't be using that multiple. We will continue to monitor this distressed debt case closely in the coming months.