Tuesday, July 10, 2007

Angelica and Pirate Capital

In a recent post about Value Creation or Destruction, we had highlighted Angelica (AGL) as a company that in my opinion, was failing to create shareholder value and was consequently, subject to shareholder activism. We had cited Pirate Capital's involvement in the stock.

As we had pointed out, free cash flow had been negative for three of the last five years as a result of increasing capex intensity. The resultant returns on invested capital have not been encouraging with the last two years just between 1% and 1.6%.

Yesterday, Pirate filed another 13-D with an interesting letter to the board of AGL. They highlight their greater alignment with AGL shareholders versus management:

"Contextually, we want to impress upon the Board that Pirate remains a beneficial owner of Angelica stock, with approximately 935,000 shares, or almost 10% of Angelica's outstanding shares. On the other hand, executive officers and directors beneficially own just over 260,000 shares (including restricted stock units), in the aggregate, and have been granted, without purchase, options on just over 440,000 shares, based on the Company's latest proxy statement. Clearly, based on our ownership, we believe that we are more closely aligned with shareholder interests than Angelica's management."

The letter also questions the valuations that management has been willing to pay for its acquisitions vis-a-vis the valuation accorded the stock itself:

"The greatest area of consternation to us, as the second largest shareholder in Angelica, is the disconnect, or the meaningful valuation gap, between the aggregate price that Angelica paid for the 11 bolt−on acquisitions made between 2003 and 2006, which we understand to be in excess of $125 million, or approximately 1x sales, and the current market valuation for Angelica, which closed last night at $22.36 per share, or just over 0.5x fiscal 2006 total gross sales for Angelica."

I can understand their concern. Since the beginning of 2003. AGL has generated a cumulative $124 million in operating cash flow. of which $105 million was sustainable operating cash flow (after debt service and non-recurrings.) About $130 million was expended to support operations through capex and operating related intangibles. Some $76 million in long-term debt has been added. As is clear, free cash flow over the period was negative at -$26 million . Contrast this with the period since the beginning of 1999 through 2002 where $150 million in free cash flow was generated cumulatively and $77 million in long term debt was paid down. Operating cash flow over this previous period was $231 million of which about $186 million was sustainable.

By their nature, capital expenditures can be lumpy and may cause temporary setbacks to free cash flow over time. But over longer term periods, these expenditures tend to smooth out. The trends here are not very encouraging.

Disclaimer: Neither I, my family, or clients have a current position in Angelica.


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