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More Thoughts on Sears’ Quarter

Post author By ToddSullivan
Post date August 28, 2008
2 Comments on More Thoughts on Sears’ Quarter

Retails is lousy now, we know that and Sears is in the unenviable position of being both a clothing retailer and a housing supplier (appliances, tools etc.). With the expected downturn there, how did we hold up and are the reason we invested in the company still valid??

In a word yes. Here are the key take-away points (more will be available when the 10-Q is filed Friday). Remember, I expected a small loss

– $500m inventory reduction
– Added 65 net stores since last year which consist of Home Appliance Showrooms, dealer stores and outlet stores, and have continued to expand online and multi-channel capabilities. In May they nearly quadrupled the number books, DVDs, music and software available at sears.com.
– CEO Bruce Johnson said, “We expect to generate higher EBITDA in the second half of this year as compared to the corresponding period in 2007 as we benefit from our lower domestic inventory levels and continued vigilant expense management. Given our year-to-date results and the state of the economy, our current full-year EBITDA forecast, which assumes flat to modest comparable store sales declines for the rest of the year, is comparable to, but no longer exceeds, last year’s EBITDA”.
– Repurchased $5.6 million shares in Q2 bringing outstanding count to 126 million as of 8/2 (watch the 10-Q Friday, Lampert is famous for buying shares between the end of the quarter and the 10-Q filing).
– Cash sat at $1.5 billion, down $100m from Q1.
– LT Debt reduced from $2.6b in Q1 to $2.2b in Q2

So, why did we buy Sears? Lampert was producing profits, reducing debt, buying back shares and fixing two bankrupt retailers (Kmart was BK and Sears was days away from it).

All of those items are still happening. Yes, profits are falling (key word being profits) but so are those at JC Penny (JCP), Home Depot (HD), Lowes (LOW), Macy’s (M) etc. What we want to know is, if we assume sales and profits are going to fall until the economy and in Sears case, housing stabilizes, what is happening to the financial condition of the company?

In the case of Sears, the balance sheet is in the top echelon of retailers with the exception of Wal-Mart (WMT) and Target (TGT).

Cash is stable, debt is being reduced and shares repurchased. Shorts are going to get squeezed here. Ackman, Lampert and Berkowitz will not dump shares and they hold roughly 65% to 70% of the total and Lampert keeps reducing share count through the buybacks. If you do the math, there are plenty of shorts out there “swimming naked” that will be fighting for shares when they have to cover.

That, will cause a surge in shares, a big one….

Full SEC Filing

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American Express: "Junk"?

Post author By ToddSullivan
Post date August 28, 2008

This is how you know the market is suffering a severe dislocation in valuations..

American Express (AXP) recently sold a bond issue that yielded 7.34%. 7.34%? for reference anything above 7% has typically be lumped in the category of “junk bonds”.

AXP, it should be noted is rated “A” by the Standard and Poors rating agency. The top rating AXP could have is “AAA” and typically junk bonds have rating 6 levels below that of “A”.

In the past AXP has issued debt in the 5% range which means bond investors are getting 40% more yield on AXP bonds currently and let’s be honest, the risk of default here is virtually non-existent.

It is strange times we are investing in……

Disclosure (“none” means no position):
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Sears Holdings Reports..

Post author By ToddSullivan
Post date August 28, 2008

Sears Holdings (SHLD) reported this morning.

From the press release:

Sears Holdings Corporation(SHLD) today reported net income of $65 million, or $0.50 per diluted share, for the second quarter ended August 2, 2008, compared with net income of $173 million, or $1.15 per diluted share, for the second quarter ended August 4, 2007. Our second quarter 2008 results include the positive impact of the reversal of a $62 million ($37 million after tax or $0.29 per diluted share) reserve because of the overturning of the previously disclosed February 2, 2007 adverse jury verdict relating to the redemption of certain Sears, Roebuck and Co. bonds in 2004. Excluding this item, earnings per diluted share were $0.21 for the second quarter of fiscal 2008. The decline in our second quarter results from the same quarter last year primarily reflects lower operating results at both Sears Domestic and Kmart, partially offset by improved operating results at Sears Canada.

“Our second quarter results reflect the continued effects of a slowing economy which contributed to the earnings declines we have experienced since the third quarter of 2007,” said W. Bruce Johnson, Sears Holdings’ interim chief executive officer and president. “While it was a difficult quarter, we were successful in reducing our domestic inventory levels by $500 million which should lead to lower markdowns and favorably impact our gross margin rates in the second half of the year.”

Mr. Johnson added, “We expect to generate higher EBITDA in the second half of this year as compared to the corresponding period in 2007 as we benefit from our lower domestic inventory levels and continued vigilant expense management. Given our year-to-date results and the state of the economy, our current full-year EBITDA forecast, which assumes flat to modest comparable store sales declines for the rest of the year, is comparable to, but no longer exceeds, last year’s EBITDA”.

Revenues and Comparable Store Sales

For the quarter, Sears Domestic’s comparable store sales declined 6.7% while Kmart’s comparable store sales declined 5.6%. Total domestic comparable store sales declined 6.2%. The comparable store sales declines at both Kmart and Sears Domestic continue to reflect increasing competition and weakness in the general economy, but are less than the declines reported by Sears Domestic and Kmart during the first quarter of 2008 of 9.8% and 7.1%, respectively. Comparable store sales declined for the quarter across most major categories at both Kmart and Sears Domestic, but continue to be offset by increases in sales of consumer electronics. Comparable store sales declines continue to be driven by categories directly impacted by housing market conditions (including home appliances and, most notably, tools at Sears Domestic), and the increased costs of consumer staples, such as food and gas, which decrease consumers’ discretionary spending.

Bruce Johnson noted that, “Despite the difficult economic environment, we remain focused on long-term value creation and continue to invest in the future of the Company. Since last year we have added 65 net stores, which consist of Home Appliance Showrooms, dealer stores and outlet stores, and we have continued to expand our online and multi-channel capabilities. In May we added a huge selection of books, DVDs, music and software to sears.com, nearly quadrupling the number of products available.”

For the quarter, our total revenues declined $0.5 billion to $11.8 billion in fiscal 2008, as compared to $12.3 billion for the second quarter of fiscal 2007. The decrease in revenue primarily reflects the impact of lower domestic comparable store sales.

Operating Income

For the second quarter 2008, we reported operating income of $187 million, as compared to operating income of $332 million in the second quarter of fiscal 2007. The decrease in operating income was mainly due to lower gross margin generated at both Kmart and Sears Domestic. We generated $3.1 billion in total gross margin in the second quarter as compared to $3.4 billion in the second quarter last year. Our gross margin rate decreased by approximately 120 basis points to 26.5% and reflects rate declines for both Sears Domestic and Kmart due to increased markdown activity as a result of the intense competition for consumer business. Domestic gross margin rate was also reduced as a result of a $36 million increase in inventory reserves over the reserve for the comparable period last year primarily attributable to the reset of the Sears home electronics department and transition to newer products. The decline in Sears Domestic and Kmart gross margin rates was somewhat offset by an increase in the gross margin rate at Sears Canada. Given that we do not expect any significant near-term improvement in the overall retail environment, we believe that our sales and gross margin will likely continue to be pressured by the above-noted unfavorable economic factors for the balance of fiscal 2008.

Declines in sales and gross margin were partially offset by declines in selling and administrative expenses for the quarter. Selling and administrative expenses for the second quarter of 2008 include the above-noted impact of $62 million related to a favorable legal judgment. In addition to the legal judgment, selling and administrative expenses declined $46 million, mainly as a result of our focus on controlling costs. This additional decline was comprised of decreases in domestic operations of $54 million and a slight increase of $8 million at Sears Canada. The decline in domestic selling and administrative expenses is primarily due to lower payroll and advertising expenses. The increase in Sears Canada was primarily due to changes in foreign currency exchange rates.

Financial Position

We had cash and cash equivalents of $1.5 billion at August 2, 2008 (of which $771 million was domestic and $763 million was at Sears Canada) as compared to $2.6 billion at August 4, 2007 and $1.6 billion at February 2, 2008. During the first two quarters of 2008, significant uses of cash included share repurchases of $477 million (as discussed further below), capital expenditures of $277 million and long-term debt repayments of $179 million. These amounts were partially offset by an $812 million increase in short-term borrowings, primarily through borrowing on our $4 billion credit facility.

Merchandise inventories at August 2, 2008 were $9.8 billion, as compared to 10.2 billion at August 4, 2007. Domestic inventory declined from $9.4 billion at August 4, 2007 to $8.9 billion at August 2, 2008, reflecting the effectiveness of our efforts to control inventory levels. Sears Canada’s inventory levels increased approximately $80 million from August 4, 2007 to $880 million at August 2, 2008. The increase in Sears Canada’s inventory is partially due to the change in exchange rates. As we expect difficult economic conditions to persist in the near term, we intend to continue to manage our inventories throughout the remainder of the year with the goal of further reducing our domestic merchandise inventories to better align current levels with expected sales.

Share Repurchase

During the 13- and 26- week periods ended August 2, 2008, we repurchased 5.6 million and 6.0 million of our common shares at a total cost of $437 million and $477 million, respectively, under our share repurchase program. As of August 2, 2008, we had remaining authorization to repurchase $206 million of common shares under the share repurchase program. Share repurchases may be implemented using a variety of methods, which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, the purchase of call options, the sale of put options or otherwise, or by any combination of such methods. Timing of repurchases is dependent on prevailing market conditions, alternative uses of capital and other factors. Since the third quarter of fiscal 2005, when our repurchase plan was first approved, we have repurchased approximately 38.7 million of our common shares at a total cost of $4.8 billion pursuant to the program. As of August 2, 2008, we had approximately 126 million common shares outstanding.

This is better than I expected it to be…more later

Disclosure (“none” means no position):Long SHLD
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Thursday’s Links

Post author By ToddSullivan
Post date August 28, 2008

Funny, Phones, SAT, Biden,

– A classic

– Dealbreaker.com votes for the Blackberry

– Just great………..going backwards. Rather than parent harping on teachers to “give” better grades to their kids, or teachers appeasing demanding parents, why don’t we just make kids “earn” them.

– This didn’t take long

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Durable Goods, Or The Reason to Ignore Most Economists (update w/video)

Post author By ToddSullivan
Post date August 27, 2008

Is it just me but outside of housing are things always coming in “better than expected”?

Durable goods orders (manufactured goods designed to last at least three years) increased 1.3% last month to a seasonally adjusted $219.26 billion, the Commerce Department said today. Excluding transportation, durable orders rose a promising 0.7%.

Orders in June were revised higher, also rising 1.3%; previously, June durables were seen rising 0.8%.

The report was much better than Wall Street expected; economists had forecast a decline of 0.4% for July. It should be noted that the June revisions mean econoists were far off the mark then also.

A gauge of business equipment spending — orders for nondefense capital goods excluding aircraft — increased in July by 2.6%, after going up 1.3% in June. Year-over-year it has increased 4.2%, indicating capital spending hasn’t collapsed despite despite dire predictions it would.

Here is the CNBC “analysis”:

The “long story short” translation here is that other than housing, the economy is still in good shape. We have yet to have a negative quarter of GDP growth, the unemployment rate, despite rising is still low by any historical measure.

Economists, far from being scientists are letting their outlook shade the reality of what is happening out there and their “predictions”. My home has dropped in value like the rest of the US’s over the last two years. But, I am not selling so, who cares? It does not have any effect on my life at all and its drop is meaningless to my financial plans in the next decade or my lifestyle. Now, it does on others, and that is why we will not grow GDP at 3% to 4%. It is the reason it will grow 0% to 2%. That is still growth.

Do home value drops matter to Caterpiller (CAT) or John Deere (DE) or other US exporters selling equipment to China, India or Brazil? It does in that their profits may drop slightly but not enough to offset a global world. Again, not great growth but growth none the less.

Housing is also the reason people think the world is coming to and end, clouding their perception of what is really happening. People losing their homes make real nice news headlines and stories, especially in an election year. Watch what happens after the election. This issue will take on considerably less importance. For now, it will be a day after day drumming of it as both parties and the media try to assess blame on everyone but the real responsible parties, lenders and borrowers.

Do not base your outlook or investments on what the economists say. Remember, they predicted a recession as early as last fall, and have still been wrong to date on that one.

Disclosure (“none” means no position):None

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Borders Earnings Call Notes

Post author By ToddSullivan
Post date August 27, 2008
2 Comments on Borders Earnings Call Notes

I think people are missing just how good a job Borders (BGP) CEO George Jones is doing there…

Notes from the earnings call:
– In the first half of this year, cash flow from continuing operations improved by $195.7 million compared to a year ago
– SG&A dollar expenses from continuing operations were $16.7 million lower than last year and are on track with stated plan to reduce annual expenses by $120 million.
– Approximately half of the $120 million in savings is related to corporate office expense reductions and the other half is reductions in store and distribution expenses. Most of the actions necessary to realize these savings have been taken.
– They are on track to realize approximately half of the expense savings, or about $60 million in 2008 and expect to be operating at a level to realize $120 million in annualized expense savings at the beginning of fiscal 2009.
– More than 28 million Borders rewards loyalty program members. This program continues to attract new members at a rapid pace. Averaging over 131,000 new members a week. Borders.com will be rolled out to stores later this year.
– Inventory reduction in music inventory, which declined over 30% from last year. They have also reduced floor space dedicated to music in all stores by about a third, on average. Music now occupies approximately 7% of total store floor space. The space previously occupied by music was reallocated to growth categories, such as children’s and bargain books.
– More space in stores due to inventory reduction allows a focus on driving profitable sales by better using that space to expand growing categories, such as children’s and bargain, as well as to face out more books and make some merchandising improvements.
– These strategies work in new concept stores and the concept stores, they are really pleased. They are performing very well on the whole and BGP will be applying them in all of our stores.

From Q&A

Regarding Pershing Square and Bill Ackman
Matthew Fassler – Goldman Sachs
“And just a really basic question on the Pershing warrants, the benefit to you is a result of what specifically be”

Edward W. Wilhelm
“Well, the warrants again have a strike price of $7, the stock being under $7 results in a downward adjustment, an income item. If things were to go the other way, it would be a — obviously an expense item if things were to, if the stock were to be over $7. And again, this is all non-cash too.”

Matthew Fassler – Goldman Sachs
“And as it moves closer to or further away from $7, you take — you book something there?”

Edward W. Wilhelm
“That’s right. And again, non-cash item.”

Cost Cutting:
George L. Jones
“One thing to note in this expense initiative, this is something we started last year looking at and had some outside help, even beginning last year, looking at the fact that we really needed lower overhead and we thought there was an opportunity to [do there]. Obviously we stepped this up quite a bit in the first of the year as we saw sales softening and what was happening with the economy and brought in some additional outside help, which really helped us focus on it at the beginning of the year. And as we put this in in second quarter, this was something that we did quite surgically with a lot of focus and literally, it was a process that was not just concentrated on let’s eliminate some jobs or do this, et cetera, which all that happened but we really literally turned over every possible stone within the company in every area and that’s the reason we are so confident that we can deliver more than the $120 million in expense reductions. And we’re still finding things.”

More on Pershing and PaperChase:
David Weiner – Deutsche Bank
“Okay, and then just one final separate question and I’ll pass it on — if you can just remind me what the implications are of not selling the Paperchase business within your agreement with Pershing? Are there kind of certain levers that happen, if I remember the Paperchase business doesn’t get sold to an outside party by the fourth quarter?”

Edward W. Wilhelm
“No, there are no implications of that, and just to be clear, the put that we have available that remains for our ability to put the Paperchase business back to Pershing Square remains in effect. We haven’t exercise the put and we obviously haven’t sold the Paperchase business either. And I would just say that as we sit here today, we’ve got plenty of available capacity to get through the peak debt season for this year and we can sit here even without the sale of Paperchase or the exercising of that put and we can say that with a high degree of confidence because that peak debt occurs early next month. So we are sitting in a very comfortable position, again even without the sale of Paperchase as we look out through the remainder of this year and again, there are no implications of not exercising that put.”

George L. Jones
“The Pershing put was really a back-stop for us to give people confidence that we had the wherewithal going forward, et cetera. That’s why it was done. It was never necessarily our intent that we would exercise it but it was there if we needed it. It was a safety net, so to speak.

Since that happened, I mean, we’ve dramatically improved the financial strength of this company and the balance sheet, as evidenced by the debt and our improvement in cash flow and everything that we have reported here. We feel really, really good about that and the expense reductions, everything we’ve got. So we’re just in a much, much stronger position financially than we were.”

More on the $120 million costs saving:
Aaron Stein – J.P. Morgan
“Okay, and then of the $120 million of annual savings, can you break out how much of that you think comes from either store closures or business spin-outs, so on and so forth versus existing operational savings?”

Edward W. Wilhelm
“None. It’s all from existing operational savings.”

What to think? This is even better than yesterday’s initial news. Why? There

We another $60 million in savings minimum this year, Borders.com results, $7 million in sales were really only after 2 to 3 weeks of operations in Q2. The new concept stores, managements reaction to them get better each quarter. Debt reduction continues.

Let’s look at the second half of the year. Last year the company lost $97 million in Q’s 3 and 4. Some real rough math gives us the above mentioned $60m in cost saving, $12m in debt interest savings, Borders.com ought to contribute $35m in sales at a real conservative minimum giving about a $8.4 m profit (using 24% gross margin). Should Paperchase be sold to Pershing, that save another $10 million in cash flow and reduces debt even further, bettering results.

I think those folks that think Borders won’t turn a profit for the second half of the year are going to be disappointed. Now, should the economy collapse, clearly we are in a different situation. But, if the worst is over and the consumer mood changes or even just stays the same, things could get a whole lot better real fast.

The cost cuts that have been made in areas that will not really involve cost increases when sales return (leases, utilities, marketing, labor, corporate expenses). The short of that is increasing dollars falling to the bottom line rather than being absorbed by expenses.

Disclosure (“none” means no position):Long BGP

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Berkshire Hathway’s Home Services Peltier on Housing

Post author By ToddSullivan
Post date August 27, 2008

Here are more thoughts n housing from the front lines and from the 30,000 foot view.

Berkshire Hathaway’s (BRK.A) Home Services on Housing

Case Schiller Results:

Simple conclusion? If your looking for that cheap vacation home, 2009 ought to be the year to pick one up on the cheap….

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Wednesday’s Links

Post author By ToddSullivan
Post date August 27, 2008

Oil, In-Laws, History, Mobil TV

– Here is the reason for the high prices

– You think your in-laws are bad?

– This is an interesting article on the Fed and history

– I already have some of this with Sprint

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Borders Earnings / Debt Reduction Beat Estimates

Post author By ToddSullivan
Post date August 26, 2008
2 Comments on Borders Earnings / Debt Reduction Beat Estimates

The really good news here is the reduction of debt by almost 40% YOY.

From the release:

Borders Group, Inc. (BGP) today reported results for the second quarter, ended Aug. 2, 2008. The company generated a second quarter loss from continuing operations of $11.3 million or $0.19 per share, which represents an improvement over the same period last year when Borders Group recorded a loss of $18.1 million or $0.31 per share. On an earnings per share basis, this represents an improvement of 38.7%.

In the first half of the year, operating cash flow from continuing operations improved by $195.7 million. The company generated operating cash of $50.7 million from continuing operations in the first half of the year compared to operating cash used of $145 million in the same period a year ago with the improvement due to tighter management of inventory and other working capital. Inventory from continuing operations decreased at cost by $181.7 million in the second quarter compared to the same period last year. Debt — including the prior-year debt of discontinued operations — was reduced by approximately 37% or $272.7 million at the end of the second quarter to $465.7 million, which compares to $738.4 million for the same period a year ago. The debt reduction was driven primarily by improved management of inventory and other working capital, lower capital expenditures, and proceeds from the previously announced sale of the company’s Australia/New Zealand/Singapore businesses.

Total consolidated sales from continuing operations in the second quarter, at $749.2 million, were down 6.9% over a year ago.

So, we know the economy is slowing and retail sales are suffering yet quarter after quarter Jones is delivering increasingly positive results for shareholders. “We have not only improved profitability, but also substantially reduced debt, improved cash flow and significantly strengthened our balance sheet,” said Borders Group Chief Executive Officer George Jones. “Our focus on expense reduction, inventory management and improved gross margin is clearly working, and we have managed to show substantial improvement in a very difficult retail environment. We will maintain this discipline and continue to manage the company prudently while also addressing the need to improve the top line.”

How did online sales go? In the second quarter, Borders.com generated sales of $7.4 million. This compares to “sales at BarnesAndNoble.com were $99.8 million for the quarter a 3.6% comparable sales increase “. It means Borders has lot of room to grow. All said, $7.4 million of sales in only 8 weeks of Q2 bodes very well indeed for the upcoming quarter that will have a full quarter of results to it for the online business.

More after the earnings call tomorrow morning…….

Disclosure (“none” means no position):Long BGP, none,

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Some Additions at Sears Holdings

Post author By ToddSullivan
Post date August 26, 2008

The best news here is the new head of the “Big three” brands at Sears Holdings (SHLD)

The former head of Motorola’s (MOT) mobile devices business, Stu Reed, will become senior vice president of Sears’s home services unit. His predecessor was Mark Good. Former Procter & Gamble (PG) senior executive Guenther Trieb will take charge of the Kenmore, Craftsman, and Diehard brands.

Trieb spent 24 years with Procter & Gamble, Co., where he was most recently vice president for the company’s Western European feminine care global business unit. that division has been growing “mid to high single digits” according to PG. Trieb also held a variety of senior leadership roles in brand management, marketing and strategic planning while with Procter & Gamble.

Sears also announced the impending departure of Chief Marketing Officer Maureen McGuire. Senior VP Richard Gerstein, also of the marketing team, will serve as chief marketing officer of Kmart and Sears. This one is a wash.

I think we all agree that the “Big 3” brands are under-monetized currently to what their potential is and the addition of a successful PG exec who has spent 24 years monetizing brands, ought to be good news for shareholders.

Disclosure (“none” means no position):Long SHLD, none

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Fed Auction Results Released

Post author By ToddSullivan
Post date August 26, 2008

this is the lowest bid toi cover ration yet…good news.

On August 25, 2008, the Federal Reserve conducted an auction of $75 billion in 28-day credit through its Term Auction Facility. Following are the results of the auction:

Stop-out rate: 2.380 percent

Total propositions submitted: $84.168 billion
Total propositions accepted: $75.000
Bid/cover ratio: 1.12

Number of bidders: 66

Rate seem to be holding steady and the number of bidders, or at least the amount of funds requested is falling. I think we may be able to extrapolate less desperation of financials once the are “un-bided” for funds.

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Fed Minutes Released

Post author By ToddSullivan
Post date August 26, 2008

Here are some of the key sections.

Growth:

In their discussion of the economic situation and outlook, many FOMC participants noted that recent developments suggested that economic activity was likely to remain damped for several quarters. Although economic growth in the second quarter had apparently been boosted by fiscal stimulus, resilience in consumption spending even before tax rebates were distributed, and robust gains in exports, recent indicators pointed to a near-term deceleration in household spending and to softer export demand. Moreover, increasing concerns about financial institutions had contributed to a widening of some risk spreads and a further tightening of credit to households and businesses. Growth in overall economic activity was generally expected to be weak during the remainder of 2008 before recovering modestly next year, and nearly all meeting participants saw continuing downside risks to growth. Recent readings on inflation had been high, but growth in unit labor costs had remained subdued and commodity prices had declined of late. Accordingly, most participants anticipated that inflation would moderate in coming quarters. However, participants also expressed significant concerns about the upside risks to inflation, particularly the risk that longer-term inflation expectations could become unmoored.

Inflation:

Headline inflation was generally expected to moderate in coming quarters, reflecting importantly an anticipated leveling-out of prices for energy and other commodities. Although measures of core inflation might well edge up later this year, given the pass-through to final goods prices of earlier increases in the prices of energy and other inputs, most participants anticipated that core inflation would edge back down during 2009. Some participants reported that firms were increasingly using various pricing strategies–such as escalation clauses or the imposition of fuel surcharges–to pass higher costs on to their customers, who were apparently becoming less resistant to such price adjustments. However, one participant mentioned the difficult pricing decisions of manufacturers who face a combination of elevated input costs along with weakening demand for their products. And a number of participants noted that the outlook for slack in resource utilization should tend to limit the extent of pass-through, contain the degree of inflation spillover to goods and services without high commodity content, and reinforce the anticipated moderation in inflation.

Full Release

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An Einhorn Classic

Post author By ToddSullivan
Post date August 26, 2008

This is beautiful stuff. David Einhorn’s Greenlight Capital has files a 13D/A in MI Development (MIM) in regards to its investment in Magna Entertainment Corp. (MECA). The letter is classic Einhorn. First he reviews his prior concerns, then lists managements dubious actions, then questions them reminds them of their duty.

First the details, according to the filing:
(a) Greenlight LLC is the beneficial owner of 2,234,000 Class A Shares. Greenlight Inc. is the beneficial owner of 2,466,000 Class A Shares. Mr. Einhorn, as the principal of Greenlight and the Affiliates is the beneficial owner of 5,036,335 Class A Shares.
(b)Greenlight LLC is the beneficial owner of 4.8% of the outstanding Class A Shares. Greenlight Inc. is the beneficial owner of 5.3% of the outstanding Class A Shares. Mr. Einhorn is the beneficial owner of 10.9% of the outstanding Class A Shares. These percentages were determined by dividing the number of Class A Shares beneficially owned by each of the reporting persons by 46,160,564, the number of Class A Shares outstanding as of June 30, 2008, as reported in the Issuer’s Second Quarter Report 2008, filed as an exhibit to Form 6-K on August 8, 2008.

In the accompanying letter, Einhorn says:

Dear Sirs:
We are writing to express our concern about MI Developments’ (“MID”) investment in Magna Entertainment Corp. (“MEC”). Given the dire situation at MEC, the MID Board needs to take the necessary actions to enforce or preserve the value of MID’s $267 million senior debt investment in MEC and not compound the risk to MID by continuing to fund MEC or extending the maturity of existing debt.

It is clear that MEC is in serious financial trouble. According to the MEC press release issued on August 5, 2008, “… the Company has needed and will again need to seek extensions from existing lenders and additional funds in the short-term from one or more possible sources.” MEC’s stock price has fallen over 90% since MID’s Board of Directors claimed in 2005 that it was adopting its own recommendation to direct management to maximize the return on MID’s current and future investments in MEC by examining the funding necessary for MEC’s strategic plan, stabilizing MEC’s capital structure, and assessing all reasonable financing alternatives for MEC. At that time MID’s Board determined that MEC was poised for growth and Frank Stronach expressed a vision that MEC would become the most profitable company in the world.

While we disagreed at the time with the Board’s assessment of MEC’s prospects, MID asserted that this was simply a question about short-term versus long-term value creation and that reasonable people could disagree.

Since Magna spun-off MEC over eight years ago, there has been a favorable environment for the U.S. consumer, and the gaming industry has experienced significant growth. MEC failed to create any value during that favorable part of the cycle. Instead, it has been a case-study in mismanagement and poor resource allocation. Its prospects were dim even before the cycle turned against the U.S. consumer and the gaming industry.

MEC’s situation and prospects are no longer matters on which reasonable people can disagree. The facts are obvious and beyond dispute: MEC has utterly failed as a business enterprise. More money, time and resources will not resuscitate it under Mr. Stronach’s leadership or anyone else he appoints to pursue his so-called vision. After many years of failure, MEC still has no viable business plan.

MEC’s plan to eliminate its debt by December 31, 2008 has also failed. On MEC’s conference call on August 6, 2008 (the “MEC Call”), Mr. Stronach stated “…we do not expect to achieve our previously announced targets of eliminating our debt by December 31, 2008.” In addition, MEC’s 10-Q for the quarter ended June 30, 2008 (the “MEC 10-Q”) states that “…we do not expect to execute the Plan on the originally contemplated schedule, if at all.” (emphasis added). Even MEC’s convertible subordinated bonds that mature shortly are now trading at only fifty cents on the dollar.

The MEC debt reduction plan has been such a dismal failure that according to the MID press release issued on August 8, 2008 (the “MID Release”), MEC’s net debt has actually increased by $21.6 million, from $564.5 million to $586.1 million, during the period from December 31, 2007 to June 30, 2008 when debt reduction was supposed to be MEC’s main priority.

MID’s equity investment in MEC is clearly no longer a strategic investment. Yet in the face of the rapidly deteriorating situation at MEC, the MID Board has continued to extend the maturity of the senior debt owed to it by MEC.

In light of MEC’s financial situation, we would have expected MID to see that MEC took aggressive steps to reduce its debt, or otherwise attempt to stabilize its financial situation. Instead, the MEC 10-Q threatens the abandonment of its plan to sell assets to reduce debt by stating “…given the announcement of the MID reorganization proposal, and pending determination of whether it will proceed, we are in the process of reconsidering whether to sell certain assets that were originally identified for disposition under the Plan.” Mr. Stronach made a similar statement during the MEC Call.

On the MEC Call, in an ominous and thinly veiled threat to the public MID shareholders, Mr. Stronach said “…I have some — call it some chips in my hand which the MID shareholders would like to have. And I have no problems releasing those chips or giving up those chips, providing it’s a fair thing for MEC.”
A reasonable interpretation of this statement in light of Mr. Stronach’s MID reorganization proposal is that Mr. Stronach intends to hold MID hostage until MEC is fully funded and Mr. Stronach has received a very large personal pay-off at the expense of the MID shareholders.

To that end, among other things Mr. Stronach has overseen (1) MID’s failure to implement any of its own 2005 Board approved resolutions; (2) the inexplicable “destruction” of MID’s relationship with its largest customer (Magna) which Mr. Stronach also controls; (3) MID dramatically increasing its exposure to the deteriorating investment in MEC through project financings and bridge loans on which MEC has been unable to perform; and (4) MID and MEC’s repeated failures to implement any recognizable business plan.

MID shareholders have been threatened that if they don’t capitulate to Mr. Stronach’s demands, MID will continue to fail to take any action to create shareholder value and, in fact, will destroy additional value through unlimited support of MEC, including perhaps buying the company. Undoubtedly this is why a majority of them were intimidated enough to support a reorganization proposal that otherwise made no sense.

We at Greenlight will remain vigilant in our efforts to protect ourselves and our fellow minority shareholders from what we believe to be oppressive treatment. We have never before witnessed such overt aggression by a business leader against a company he controls.

Despite Mr. Stronach’s actions and intentions, each and every member of the MID Board of Directors has a fiduciary duty to all of the shareholders of MID, not just to Mr. Stronach, and the Board must explore all of MID’s alternatives with respect to MEC, not just the ones that Mr. Stronach wants. It may be that Mr. Stronach can vote his shares on matters subject to shareholder vote as he wishes. However, there are many protective actions MID’s Board can take that do not require a shareholder vote and would mitigate the harm that Mr. Stronach is trying to inflict on the company.

MID’s Board must stop expending any more funds to prop up the value of the MEC equity, should not bail-out MEC’s subordinated bondholders and should stop coercing (including by failing to take affirmative action to protect shareholders) the MID shareholders into approving Mr. Stronach’s terms. MID’s Board is duty bound to resist Mr. Stronach’s efforts to use MID’s money in this regard.

Given that MEC’s equity is no longer a strategic investment for MID, rather than blindly continuing to extend the maturity of the senior debt, MID should act like an independent third-party lender and explore all of its options with respect to MEC. There are several possible options MID’s Board can implement that would not require Mr. Stronach’s personal support, including foreclosing on the senior debt or marketing its MEC debt position for sale to a third party. MID’s Board of Directors has a fiduciary duty to protect the shareholders of MID, not to focus as Mr. Stronach says on what’s a “fair thing for MEC.”

By continuing to extend the senior debt, rather than exploring all of their options, the MID Board is endangering MID’s senior debt investment in MEC and is making repayment of the debt in full less likely with each passing day.

If MEC fails to repay its debt to MID in full, the members of the MID Board will be held accountable for failing to fulfill their fiduciary duty to the MID shareholders. We minority shareholders are looking to you to protect our interests from Mr. Stronach’s continued irresponsible, uneconomic and self-serving support of MEC.

Mr. Stronach said during the MEC Call, “I wouldn’t throw money in an empty hole.” Why has so much of MID’s money met exactly that fate?

This is what makes Einhorn so good, not only does he seem to have a better handle on the companies he invests in that those who run them do, he, unlike them in many cases has more concern for shareholders than they.

Disclosure (“none” means no position):none

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Tuesday’s Links

Post author By ToddSullivan
Post date August 26, 2008

Patriotism, Foreclosures, Biden, Sequoia

– If you need to tell folks……you have a major problem.

– Cheap stuff from the bank

– So, this is the guy? Really? Is Obama bent on losing?

– This bears looking into

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Bove on Fuld (video)

Post author By ToddSullivan
Post date August 25, 2008

Bove in on the tube more recently than either Obama or McCain.

Watch the video:

Bove is right that replacing Lehman (LEH) CEO Dick Fuld will not “fix” Lehman. But, Fuld is responsible for the mess they are in and replacing him would be a step in the right direction to restore investor optimism.

Fuld clearly has not had a grasp on what is happening there, or, does and has been less than forthright with investors. Either scenario ought to remove him from the top spot.

Let’s reverse it. What will keeping him due do to better the situation? Lehman is still going to have to hold a fire-sale with or without him. A move to a new guy might at least stabilize things and give the company, which relies on its reputation for its business some breathing room.

Lord knows it would be hard to make things worse…

Disclosure (“none” means no position):None

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