The Citron Year in Review 2008

,

It is now obvious that 2008 has been a watershed year for equity markets.  Citron does not celebrate the devastation of capital that many investors, both large and small, active and passive, suffered this year as the speculative debt bubble burst and equities deflated. 

It’s just not our style to take a victory lap; however, we do seek to define our place in the world of newsletters.  Recently Marketwatch.com listed the top 10 newsletters from 2008, and we noticed our absence. 

http://www.marketwatch.com/news/story/2008s-star-newsletter-profits-stars/story.aspx?guid=%7BFFA002E0%2DCA5E%2D4E4F%2D917D%2D1CC76936F341%7D

What makes this noteworthy is that we have never made that list, yet Citron would offer its track record head-to-head against any newsletter in this country, over the last year or over a 7 year span.  We understand that our words might be a bit more colorful than the next guy, but that should never distract readers from the credible and verifiable information that Citron provides to the investment public….at no charge.

For the last seven years Citron’s motto has been, “Cautious Investing to All”. 

2008 provided an overwhelming lesson in why caution is necessary when it comes to deploying your own capital.  Whether you are investing with T Boone Pickens, Bernard Madoff, or with any analyst that posts a “strong buy”, greed should be counterbalanced with an equivalent measure fear, and buttressed with a healthy dose of skepticism.

We’ve assembled a basic summary of all the stocks we’ve reported in 2008. It has never been Citron’s strategy to try to outguess the markets, or engage in market-timed trading.  But even against a baseline of an expected 30% or 40% equity loss, Citron’s skepticism in regard to the specific stocks it analyzed was borne out. 

Despite bullish opinions and buy ratings by numerous analysts, Citron’s two most often reported stocks – Arthrocare (NASDAQ:ARTC) and Emcore (NASDAQ:EMKR) have both fallen by 90%.  8 of the 11 stocks Citron covered performed worse than even the adverse market of 2008. Only 1 of the 11 is trading moderately higher than when we first reported it (HEV), and we do not believe that will be for much longer.

It remains Citron’s firm conviction and investment philosophy that companies engaging in misleading financial reporting, or operating business models that defraud consumers, will underperform the market over time, in both bull and bear markets.  We appreciate our readers and we hope that they will regard Wall St. in a different mindset 2009 – a mindset that demands accountability from analysts and listens to the warnings of contrarians.

We believe the truth is out there, and it is valuable.

Please look at the data and draw your own conclusions.  For 2009, we would hope that CNBC would adopt our motto “Cautious Investing to All”

Citron 2008 — Summary of Stock Research and Outcomes

2008 Reported companies

Number of times reported

Closing Price on
12/30/08

Price when reported — High

Price when reported — Low

Pct Change from High

Pct Change from Low

Days since first reported

ARTC

14

4.81

52.14

44.15

-90.77%

-89.11%

375

EMKR

6

0.78

8.20

6.14

-90.49%

-87.30%

279

AMSC

3

15.56

45.78

29.38

-66.01%

-47.04%

230

BWTR

1

0.44

6.22

 

-92.93%

266

VLNC

1

1.76

4.46

 

-60.54%

264

PDO

1

4.00

32.80

 

-87.80%

188

HEV

2

7.22

6.70

5.06

7.76%

42.69%

166

AMED

1

42.21

66.13

 

-36.17%

139

FOUR

1

1.70

9.60

 

-82.29%

137

RBCAA

1

25.90

25.21

 

2.74%

67

LTM

2

12.37

13.25

11.2

-6.64%

10.45%

39

 

Citron Updates Lifetime Fitness

,

In our first installment on Lifetime Fitness (NYSE:LTM), we promised our readers to update the story and describe the parallels between Lifetime Fitness and Bally’s Total Fitness.  Well, stop the presses.  Much has changed.  Yesterday, just 14 short months after emerging from Chapter 11, Bally’s filed for bankruptcy protection — again.

http://www.marketwatch.com/news/story/Bally-Total-Fitness-Files-Chapter/story.aspx?guid=%7B6CDA1F5A-73AF-42AA-9C33-6CDC7D915C88%7D

http://www.bloomberg.com/apps/news?pid=20601087&sid=aaYCJ1Pm5O.g&refer=home

Just 14 months ago, Harbinger Capital Partners led a cash infusion of $233 million into Bally’s.  Harbinger has already taken the write-down.  It is the opinion of Citron that this is the inevitable fate of Lifetime Fitness.  As LTM increases long term debt to over $900 million this year, we point out a quote from the current CFO of Bally’s Fitness:

“The burden of Bally’s long-term indebtedness, coupled with the lack of refinancing options in today’s constrained credit markets” left no alternative to a bankruptcy filing, despite marked improvement from an ongoing restructuring”

Currently Lifetime lists assets as $1.45 bil in PPE — with scant $7.1 million cash on the books.   Its heavy assets are exercise equipment, and monolith gyms in predominantly suburban communities.  The next biggest line item in assets is “other” … which accounts for $56 million.  We still do not know what this “other” is.  Yet, it appears to Citron that Lifetime is one write-down away from a balance sheet that mirrors on a proportion and scale that of Bally’s Fitness : $1.4 bil in assets and $1.5 bil in debt.

Citron admits, the massive dumping of the stock by the CEO  is nothing more than a sideshow if the business is actually viable.  Unfortunately, this sideshow might turn out to be a precursor to what we are really seeing in an underlying business.  As just stated by the CFO of Bally’s, the company “encountered a liquidity crisis” in the summer of 2008 because of declining fees and dues and rising operating costs and capital spending.”

The credit and liquidity crisis have not only hurt the consumers who are rethinking their health club memberships but more importantly have affected the lenders who are thinking twice about the viability of this type of business model.

Financials

LTM’s huge fitness centers are the “theme parks” of the health club business.  With current models costing over $30 million apiece to build, and spanning 110,000 sq ft, these high-end emporiums of sweat include trendy cafes, water slides for the kids, and upscale spa retreats.   While we commend Lifetime on building these beautiful clubs, we have to question the economic viability of this business model as American’s are tredning towards a more cost conscious lifestyle.  Lifetime’s consumer-friendly business model has been to avoid high membership buy-ins, and instead to have members sign up for monthly withdrawals for membership fees that are the highest in the industry, ranging from $70 to over $100 per month.

The question is whether this revenue stream has any chance of holding strong in the unprecedented US economic storm now unfolding. Consumers are caught with all three of their wealth sources under extreme duress:  devastated real estate values, devastated investments, and rapidly rising unemployment.  Across the spectrum of consumer activity, retail operations are reporting double digit declines and same store comps.  Credit card issuers are slashing credit lines (by an estimated 2 trillion) as lenders fear unsecured credit card limits, as the lenders of last resort, will be drawn down by panicky consumers without the means to pay it back.

Yet, LTM’s guidance asks us to believe that come hell or high water, its customers, who have no lock-in to their memberships, will just keep doing their sweating at LTM’s clubs, uninterrupted.  It is unfathomable to Citron that LTM won’t see the same double-digit revenue decline in a revenue stream that is 100% consumer discretionary.

Meanwhile LTM’s debt levels are at high stress levels.  Based on its own numbers, its EBITDA per member keeps trending down, while its net debt per member continues to ratchet up.  If the company keeps adding its two centers a quarter, revenue per member declines just 5% as per current trend and membership per center is flat year over year (all optimistic per current conditions), we see the following:

LTM

Q ending June  07

Q ending Sept  07

Q ending Dec  07

Q ending March 08

Q ehding June 08

Q ending Sept 08

Trend  Dec 08

Trend  March 09

Trend  June 09

Trend  Sept 09

EBITDA/member

99.97

106.85

107.63

103.12

106.8

110.16

87.95

83.19

82.21

83.99

                     
                     
Net Debt/member         1,174         1,079       1,248          1,325        1,456          1,312       1,463       1,494       1,550     1,693

Basically, it’s a rerun of the same unviable situation Bally’s is backed into.  These net debt per member and EBITDA per member are coming close to what we saw with Bally’s only one year before their first bankruptcy.  The absence of cash flow per member hides for a while in capex-fueled growth, but there’s ultimately no way to support the debt burden.

Private Equity

Just two weeks ago that Merril Lynch downgraded Liftetime, citing slower growth and a slower economy.  But the next day private equity group Leonard Green filed its newly taken stake.  Citron’s emails lit up from readers asking us our opinion.

While we respect Leonard Green and Partners, much like we respect Harbinger, we believe they have made a mistake.   Over the past 7 years some of the biggest names of the investment world have been on the opposite side of Citron trades — everyone from Peter Lynch, T, Boone Pickens, Goldman Sachs and the clients of numerous investment banking analysts.  Yet, they have all lost money on those investments while Citron has been proven correct in the long run.  Whether we are smart or just lucky, it is tough to argue with that track record of success. 

So don’t forget, not only has no one ever shown Citron to be wrong in 7 years (except Fairfax Financial), but at the same time no one has ever shown that they can make the mega health club chain model work  … heavy lifting even Fairfax can’t accomplish.

Cautious Investing to All.