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Dow Jones S&P 500 NASDAQ 10-Year Note
10,471.58 1,108.86 2,175.81 32.75
Oil *
79.17
UP
126.74
UP
13.23
UP
31.21
UP
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10 Yr
3.28%
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117.38
+1.23%
+1.21%
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+2.31%
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Commentary : The Turnaround Artist


What's So Great About Turnaround Investing? Plenty

By Arne Alsin
Special to TheStreet.com
12/19/2000 05:42 PM EST

We are in the midst of a rare confluence of events -- the market has experienced a savage decline, the economy is slipping and momentum investing is dead in the water. As I said in my prior column, the table is set for large, outsized profits for nimble turnaround investors.

In a few days, I will be posting my column "Top 10 Turnarounds for 2001." I have culled through hundreds of candidates to find the best turnaround opportunities for investors. Making the list are companies that have the potential to at least double in value over the next one-to-three years. In addition, the companies that have made the list have strong franchises, are very profitable and have strong balance sheets.

Remember, though, companies are not "turnarounds" unless they have issues to work through. I like to tell clients that there are only two kinds of companies: companies that have problems and companies that are going to have problems. Even a stalwart company like Microsoft (MSFT:Nasdaq - news - commentary - research - analysis) has gone from a company "going to have problems" to a company with problems.

As a turnaround investor, I am not only interested in companies with problems, I actively seek them out! There are many reasons why investors should want companies with problems:

  • More attractive prices -- Turnarounds are generally attractively priced. The more problems a company has, the larger the discount accorded the stock price. The stocks on my Top 10 Turnaround List are, on average, priced about 65% below their all-time highs. They are "on sale." Too many investors in the past couple of years were willing to pay full prices, even premium prices, for companies.

  • Problems are cyclical -- Problems come and go for most companies. The time to buy is when problems are the worst. Capital naturally flows to the hottest sectors of the economy. The result is predictable enough: Increased capital begets increased competition, which eventually causes a drop in profitability and returns on equity.

    And then the cycle turns -- capital dries up, competition is lessened and profitability eventually soars. As a turnaround investor, I am interested in areas where there is capital flight. Good times usually follow capital outflows.

    Just try getting a venture capitalist to back a business geared toward selling toys on the Internet today. Such an idea is laughable. The well of capital for Internet toy sales is bone dry.

    A year ago, we had several well-financed Internet toy retailers -- Amazon (AMZN:Nasdaq - news - commentary - research - analysis), eToys (ETYS:Nasdaq - news - commentary - research - analysis), Toys R Us (TOY:NYSE - news - commentary - research - analysis), Toysmart and others. With the recent announced problems of eToys, there may only be one large vendor left, ToysRUs.com, owned by Toys R Us, in joint venture with Amazon. The competitive landscape has quickly coalesced in favor of ToysRUs.com -- capital in the sector has dried up and most competition has been eliminated.

  • Lower risk -- Every, repeat, every investment has risks. Turnaround stocks are not without risk. Even U.S. government guaranteed paper has risks -- if interest rates go up, the value of your bill, note or bond goes down. And if you hold that bond to maturity to avoid principal risk, you still incur risks, such as inflation risk. So realize it now, if you haven't already: There is nowhere to hide as an investor.

    In my estimation, carefully selected turnaround stocks can be less risky than many, if not most, other stocks. A good example of this is Whirlpool (WHR:NYSE - news - commentary - research - analysis), a terrific turnaround stock that almost made my Top 10 Turnaround list. Whirlpool is beset by soft sales in a difficult business environment, but this is a temporary, cyclical problem. The company's financials are solid, with recent insider buying, a stock buyback program and a 3.5% dividend yield.

    Whirlpool is a real company with real earnings and real assets. The stock is not going to zero. There is an unknowable price point for Whirlpool stock at which, in normal market conditions, it will not go lower. As a turnaround investor, your objective is to buy as close to that price point as possible.

    When the business of Whirlpool begins to turn around, this $40 stock will be worth at least $60, a level it has touched or exceeded for eight consecutive years! Buy today around $40, and if it trades at $60 for a ninth consecutive year in 2001, you can pocket a 50% gain.

    Are AT&T and Lucent Turnaround Fare?

    In the email I received after my recent column many of you asked about AT&T (T:NYSE - news - commentary - research - analysis) and Lucent (LU:NYSE - news - commentary - research - analysis) as turnaround candidates. Here's my thinking: AT&T is not attractive as a turnaround because its business model has intractable problems. Long distance is a weakening commodity, with no relief in sight, and the huge amounts spent on the acquisition of cable properties has created a hefty debt load, crippling Ma Bell's financial flexibility.

    As for Lucent, I'm more positive on the underlying business. But here, the company's valuation remains too high to be an attractive turnaround candidate, at least for my discipline. The quantitative metrics I use indicate a fair value for Lucent of between $10 (worst case) to $25 (best case). I would like to provide a tighter price range for Lucent, but it is difficult to accurately gauge the depth of the problems it faces. Since the turnarounds I recommend must have a reasonable potential to double, I don't consider Lucent a buy, even assuming the best-case scenario.

    While I'm not bullish on AT&T or Lucent, look for my buy recommendations in my upcoming column, "Top 10 Turnarounds for 2001." This will be a list of companies that you won't get from your Wall Street broker because turnarounds are a hard product to sell. Brokers want to push, sell, and promote companies that don't have any problems. But, as I am fond of saying, there are only two types of companies...


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    Dow Jones S&P 500 NASDAQ 10-Year Note
    10,471.58 1,108.86 2,175.81 32.75
    Oil *
    79.17
    UP
    126.74
    UP
    13.23
    UP
    31.21
    UP
    0.74
    10 Yr
    3.28%
    SPDR Gold
    117.38
    +1.23%
    +1.21%
    +1.46%
    +2.31%
    		Data delayed 20 minutes

    Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, ACM held no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to aalsin@mail.com.
    Read our conflicts and disclosure policy.
    Order reprints of RealMoney.com articles. Top


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    Dow Jones S&P 500 NASDAQ 10-Year Note
    10,471.58 1,108.86 2,175.81 32.75
    Oil *
    79.17
    UP
    126.74
    UP
    13.23
    UP
    31.21
    UP
    0.74
    10 Yr
    3.28%
    SPDR Gold
    117.38
    +1.23%
    +1.21%
    +1.46%
    +2.31%
    		Data delayed 20 minutes