Description
Just sit right back and you'll hear a tale,
a tale of corporate schlock,
That started up in Oregon,
aboard this tiny stock.
This is the story of Fog Cutter Capital, a $30 million micro-cap company that invests in distressed real estate, and its ethically challenged CEO, Andrew Wiederhorn. How ethically challenged, you ask? Let us count the ways:
- Wiederhorn recently plead guilty to two federal, felony accounts. One was for violating an ERISA law that happened to involve Jeffrey Grayson, who pled guilty to mail fraud related to how his firm, Capital Consultants, handled a union pension fund. Wiederhorn's second felony was for filing a false tax return related to a loss sale of assets to a family-owned corporation. He reports to jail on August 2, 2004.
- Wiederhorn solely owned Wilshire Credit Corporation (WCC), which borrowed $160 million in 1998 from Capital Consultants to buy a pool of distressed loans. The loans turned out to be very distressed and the deal tanked big time. That did not stop Wiederhorn from personally borrowing $64 million from WCC, only to forgive himself
the loan before it imploded.
- Fog Cutter settled a lawsuit with an Oregon union two years agreeing to reimburse the state pension fund for $110 million in losses related to the Capital Consultant transactions.
- Wiederhorn founded Wilshire Financial Services Group (WFSG), which ended up in bankruptcy in 1998.
- While Wiederhorn was at WFSG, he bought a thrift, First Bank of Beverly Hills, which later received several cease and desist orders from the Office of Thrift Supervision related to de facto loans to WCC that were illegal.
- Fog Cutter paid $425,000 for use of a private aircraft from an entity owned by Wiederhorn.
- Wiederhorn borrowed $2 million from Fog Cutter.
- The most recent president of the company, Robert Rosen, resigned this spring and exercised a put option that required Wiederhorn to purchase 423,245 shares @ $4.02. Wiederhorn in turn sold options on these same shares to the Company for $750,000.
- The previous president, Lawrence Mendelsohn, resigned in 2002, and pled guilty to one count of filing a false tax return and is co- operating with the Capital Consultants investigation as he awaits sentencing. When he left Fog Cutter, he received and exercised a put option requiring the company to buy his one million shares @ 4.02.
For his role in all this, the Fog Cutter Board of Directors approved Wiederhorn's recent request for a paid-leave of absence while he spends 18 months in prison. Thus, he will get paid $350,000/year to sit in jail. They also paid him a special $2 million bonus (did I mention that he had to pay $2 million in restitution?) and hired Lanny Davis to do PR work. Granted, Lanny is good, as evidenced by this release:
http://biz.yahoo.com/bw/040702/25144_1.html
A few people thought Wiederhorn should have been fired, but the BoD resembles the old MCI calling plan, you know, friends and family. They feared that Wiederhorn would be able to exercise his employment agreement and collect $7.2 million in severance. They also felt that since he negotiated most of the current business that it was important to retain him.
Given all these underhanded dealings, you may be shocked by this, but I am actually recommending this not as a short, but as a long.
Thesis: Many people have jettisoned this stock and it now trades at $3.50 or 73% of book. On Friday, they announced that Ernst & Young is resigning as their auditors, so there will be even more selling pressure. They also pay a $0.13 quarterly dividend, for a 14.9% yield. I believe they keep paying the dividend and that some of their investments will increase book value. Think of this as a convertible junk bond for Fatburgers, where most of the return comes via the dividend and the underlying investments only need a modest return to propel value here. I'm looking at an 18 month price target of $4.25, which when coupled with six quarterly dividends, comes to $5.08 or a 25% annualized return.
Dividend: The key to investing here is what happens to the dividend. There is where we talk about that $2 million loan to the CEO. It is collateralized by two residential properties in Oregon, and the interest rate is 8.5%. Using just simple interest calculations, the CEO is paying at least $170,000 to the company on the loan, not including principal payments. The CEO will retain his salary of $350,000, but that won't support his family, their 25 room mansion AND pay the loan. Therefore, they will continue paying the dividend as Wiederhorn, his wife Tiffany and their children own a combined 2.8 million shares. Of course, I am going out on a limb in assuming that Tiffany is not exactly a working mom type. Notice that they started paying the dividend at the same time as the loan. Coincidence? Not with this guy.
Assets: What interests me, though, is that they have made a $7.4 million investment in a restaurant chain out West called Fatburgers through a convertible preferred and redeemable preferred, as follows:
• Series A-1 Preferred, which is convertible into common stock equaling a fully diluted 35% ownership interest in Fatburger;
• Series A-2 Preferred, which is convertible into common stock equaling a fully diluted 15% ownership interest in Fatburger; and
• Series D Preferred, which is redeemable by Fatburger for approximately $10 million, plus accrued dividends of 20% annually.
Since Fog Cutter owns 85% of the voting shares, they effectively control the company, which is now consolidated into their financials. Fatburgers currently has 56 restaurants, and has sold 250 licenses for Fatburger franchises, at $20,000 per license. Most of this money is currently on the balance sheet as a liability, under deferred income. This will be recognized as revenue when the franchisee signs a lease agreement, at which time another $20,000 is due from the franchisee, which also goes into deferred revenue until the franchisee completes training. Once the restaurant is operational, Fatburgers collects a 6% royalty fee from gross revenue. Fatburgers could be a homerun.
Fatburgers is a bit of a departure from Fog Cutter's typical investment style of investing in distressed real estate and real estate loans. However, they have shown some brains, as in buying a pool of Fannie Mae bonds in 2002, when there were no compelling investments. They have since exited the bonds for a gain. Other investments include:
-51% ownership in a California commercial mortgage bank called George Elkins Mortgage Banking Company.
- 26% ownership in BEP, which owns two shopping centers in England. Merrill Lynch (Jersey) Holdings Limited owns 71%.
- 103 freestanding retail properties. These are buildings developed in the 70's and 80's. 56 are owned and 47 are leased. 10 are vacant.
- V Model Agency. This was bought in late 2003 for $200,000. It's a Parisian modeling agency. No snickering allowed.
- $79 million of NOLS that are valued at zero. $11 million reside at Fatburgers and start expiring 2004. The remaining $68 million don't start expiring until 2018. There is some value here.
Tangible Book Value: Excluding goodwill and intangible assets, tangible book value is $3.41/share. As of 3/31/04, that included $11.6 million of cash and cash equivalents, or $1.34/share. Borrowings and notes payable came to $7.6 million
Options: There are 1.7 million options out there, with 1.8 million more available under the plan. Considering that total shares outstanding is about 8.8 million shares, it is significant; however, it is tempered by the outstanding options having a weighted average strike price of $4.57. With the CEO in jail, I doubt that they give out any more options; only fear is if current out-of-the-money ones are repriced lower.
Negatives: Although I mentioned most of the hair in this hairy beast, there are some additional things that you need to know. One is that there are share rights that trigger should anyone acquire more than 5% of the stock. Second is this is small and illiquid. Third, they are currently appealing a NASDAQ delisting.
******* While I am long, DO YOUR OWN DUE DILIGENCE! ********
So this is the tale of a jailbird CEO,
he's there for just a short time.
He'll have to make the best of things,
it's an uphill climb.
No phones, no fax, no private jet,
not a single luxury.
Like Robinson Crusoe,
it's as primitive as can be.
So join us here each week my friend,
you're sure to get a smile.
From poor corporate governance,
Here on Wiederhorn's Isle.
Catalyst
- Selling pressure over auditor resignation
- Trading just above tangible book value
- Fatburgers investment takes off