Turnaround Cases: Penn Traffic ($PTFC)
Let’s make a break with the Premier Exhibitions series. While doing some well deserved procrastination, I crossed paths with Penn Traffic Co a supermarket chain filling for chapter 11 a couple of days ago.
Retail is combat sport. Having worked for a very successful and admired retailer I learned to never start a retail business and to avoid investing in one. Why not?
Another big problem with retail is the transparency of the business. Sam Walton spent thousands of hours inside his competitors’ stores. It’s virtually impossible to have any trade secrets in retailing. Your competitors can walk into your stores and, in about 15 minutes, understand your entire business-model advantage and how to replicate it. There are very few industries that are as openly transparent, and that’s problematic for the long-term investor. – Pabrai
Large retailers are constantly trying to pick the next good location while running out of space to grow, with the competition right behind them, and paranoid of the possible appearance of a new demographic trend. “Location, location, location” and “retail is detail” does not seem too much of a competitive advantage. Because of this, retail is a low margin business with little margin for error.
It is also a business that heavily depends on the trust and credit of its suppliers. Suppliers do not want to be the last one standing with distressed receivables so in difficult times retailers can suffer the equivalent of a bank run and swiftly collapse. This makes turnarounds in retail particularly difficult.
After that nice intro you might wonder what intrigues me about Penn Traffic. Actually, it is a very good case study of what you want to avoid in a turnaround investment: a marginal business in a difficult industry. But it may also be, and may is the key word, a liquidation opportunity. To get up to speed you can find a couple of good VIC reports here and here. (subscription free)
Penn Traffic is what I call an unrepentant alcoholic with their third trip into chapter 11: not an unusual record in retail. The reasons for their problems are the two Ws: Wal Mart and Wegmans, two of the strongest retailers out there. Meanwhile, Penn Traffic has to compete with a unionized work force and small stores in suburban locations (approximately 35K ft per store).
During their previous chapter 11 they sold Big Bear their crown jewel: a bad sign. Asset divestments are common in turnarounds but you want the company to sell their marginal assets not their core. If they were forced to sell their core assets, it is very probable that their marginal assets were un-sellable.
I would say that at its current stage, Penn Traffic could still be interesting as a liquidation play and as a potential case study on the margin of safety provided by real estate assets. It still owns 17 stores and 2 shopping centers whose value is not reflected in the books, with a market value probably north of $50 million.
However, we have also to take into account the long term leases. These can be undone or renegotiated in Chapter 11 but I would be much more comfortable if the company manages to sell those stores. In the case of Penn Traffic:
I have not done the heavy lifting yet. However with the leased stores shopped around, hidden assets potentially way north of $ 50 million and still reporting $15 million of book value there might be something there for a company valued at $15 million $1.5 million. Buyer beware, bankruptcy is a highly uncertain process and I am definitely no expert.
Would love to discuss this idea with readers more informed in liquidation plays.