Description

Despite solid performance since emerging from bankruptcy in March, AMF
stock declined 34% between Oct. 7 and Nov. 15 on volume of 21,000 shares.
At its current price of $18.50, AMF is one of the cheapest, stable free
cash flow businesses you will find-4.5x LTM EBITDA of $121 million and 4.8x
LTM after-tax free cash flow per share of $3.17, both after adjusting for
the value of NOLs. There is, furthermore, significant upside in the Center
business. The board is controlled by well respected hedge funds, including
Angelo Gordon and Farallon, who have no way out absent a sale of the
company. If these funds can be expected to act in their own self-interest,
a sale of AMF via auction would appear very likely.

AMF operates two segments: Bowling Centers and Bowling Products. AMF is
the largest owner or operator of bowling centers with 387 locations in the
United States and 117 overseas. The US Centers produce stable cash flows
as do the foreign centers on a local currency basis (with the exception of
Australia). CFO Chris Caesar likes to say that Centers have neither poor
months nor great months; there just are no real surprises. It is,
therefore, a business that is relatively easy to value and safe to lever.

The upside in Centers lies in food and beverage. Food and beverage
revenues account for approximately 26% of US Center revenues. Assuming 387
US Centers generate approximately $1.1 million in revenues, on average, or
$445 million, F&B revenues total $115 million. Management estimates that
the average customer spends $1.15 per game bowled, or $3.45 on F&B (which
seems ridiculously low, particularly because it includes liquor). A
reasonable guess regarding the incremental margin on F&B sales might be
75%. Every $0.50 increase in F&B spending per person would add an
incremental $12.5 million in gross margin with no associated US taxes
thanks to the NOLs, or $1.25 per share in earnings per share. The company
is introducing lane-side service as a way to increase the average F&B
ticket, particularly when the centers are not at capacity and there is no
opportunity cost to turning the lanes more slowly. CEO Roland Smith is
credited with turning around Arby's for Triarc; he is also on the board of
Carmike Cinemas. COO John Smith, who started post-emergence, was Zone Vice
President of Starbuck's, where he was responsible for 2,600 locations. One
would hope that this management team has the requisite experience to
execute this initiative.

Bowling Products, the other operating segment, had a troubled past. The
Asian crisis caused the products division's EBITDA to fall from $70 million
in 1997 to $8m in 1999, leading ultimately to the bankruptcy filing in July
2001. Bowling products is best thought of as three businesses:
(i) consumer and after-market products, (ii) modernization products and
(iii) new center packages (NCPs). The first two of these businesses are
relatively stable with some recurring revenue streams since lanes always
need to be maintained. The problem has been with NCPs, which include all
of the equipment needed to make one bowling lane operational, including a
pinspotter and ball return (NCPs are sold in pairs since ball returns
service two lanes). At its peak, AMF sold approximately $200 million of
NCPs annually; it now sells $30-40 million. NCP sales are made overseas
almost exclusively as virtually no new centers are opened in the US.
Bowlers Journal noted: "For almost 50 years, as one market matured and
became saturated, another opened up. First the US, then Europe and the UK.
Next came Japan; after that, Korea. Then it was back to Europe and the UK.
Then Asia. In the past, the immediate prospect of a new major market about
to bloom was always with us." No new market is likely to emerge in the
near term that will increase sales substantially. The two most promising
markets today are Eastern Europe and Russia. Importantly, Russian sales
are made for 100% cash up-front and no credit risk is taken. Management
had expected Products to rebound more strongly post-emergence. Say
whatever you want about Products, it is currently free cash flow positive
and is not worth less than zero.

Post-emergence there was considerable debate about whether the disclosure
statement projections were conservative or aggressive: "projections are
aggressive by 2X historical" someone said. The company's results have
answered that debate. Projected calendar 2002 EBITDA was $126.8 million;
LTM EBITDA through September was $121.2 million. With approximately $90
million of non-discretionary annual payments (interest expense, capital
expenditures and cash taxes), there is a fairly healthy margin of safety
with respect to the company's leverage.

It was originally anticipated that management would conduct quarterly
conference calls and that the company would list on NASDAQ. While this is
not the case, management is accessible through Merrell Wreden, head of IR,
and the board's decision not to list would seem to reflect the controlling
shareholders' desire to exit via private sale rather than by dribbling out
through public stock sales.

Catalyst

Executing new F&B initiative could dramatically improve EPS.
You would be hard pressed to find a board more motivated economically to
sell a company.