Two Sell Pitches:

Hugoton (HGT) and Regis (RGS)

October 20th

James Cullen
Portfolio Manager
Boston College Investment Club
Portfolio Management Perspective
• We Still Own 35
Stocks
– Too Diversified (i.e.
Closet Index Fund)
• Raise and Redeploy
Cash
– Are HGT and RGS
Best Ideas?
– Hidden Opportunity
Costs
Via Malkiel’s “Random Walk”
• Liquidity is Key Now
 Hugoton Royalty Trust (HGT)
• Hugoton is a Royalty Trust
– Collects 80% of Profits from Natural Gas
Production on Properties Owned
• Producing Properties in Kansas, Oklahoma,
and Wyoming
• A Spinoff of XTO Energy (BCIC Owns XTO)
• Club Owns 12 Shares = $253
 Let’s Sell Hugoton (HGT)
• Natural Gas Price Volatility
– Already Have Portfolio Exposure (XOM, XTO)
• Insider Selling a Negative
– CEO Topped List of Insider Sales When We
Initially Tried to Sell
• Overpriced vs. Underlying Commodity
• Dividend Yields Can Be Deceiving
– Natural Gas Prices Fell Off a Cliff
– Durability of Property Production a Question
 Natural Gas Price Volatility

• BCIC Portfolio Also Holds XTO and XOM

– XTO: 84% of Reserves are Natural Gas (McfE Basis)
– XOM: 61.5% of Production is Natural Gas (BOE Basis)
 HGT Insider Selling

• Per TheStreet.com, Hugoton Chairman and CEO Bob

Simpson Topped the List of Insider Sales by Dollar
Volume for the Week of Sept. 30th
– Simpson’s sales were all above $29; HGT last closed at $21
• Tangentially Related: Who is Jeff Gendell?
– Manager of Multi-Billion Dollar Hedge Fund Tontine Partners
– Tontine Down Massively YTD; Liquidating Positions
– Gendell Has a Great Reputation, Look at Positions He is Being
Forced to Sell as Potential Buy Pitches
 Hugoton vs. Natural Gas

Natural gas prices drive Hugoton’s ability to pay dividends. So, it makes sense
that the price of HGT will track with the price of natural gas. The above chart
shows the relative performance of HGT relative to a natural gas ETF (UNG) –
but note the divergence of late, and how HGT is still overpriced relative to UNG.
 Don’t Trust The Dividend
• Not All Dividends Are Created Equal
– Hugoton’s Dividend Has Doubled With Natural Gas
Prices This Year
– But I’d Prefer a Coca-Cola (KO) Dividend
• i.e., Over 340 Consecutive Payments, Since 1920
• A Simple Run-Rate off the Last Monthly
Distribution Gives a 23% (!) Yield
– Sounds too good to be true…(the Cal-Maine Principle)
– No One True Yield for HGT; Dividend Floats/Changes
Monthly With Natural Gas Prices
What Will Happen to Hugoton’s Dividend?

• Distributions have a lag period. The most recent

distribution comes from a time of peak prices.
• 5 = 50 Rule of Commodities
– A 5% Price Decline Cuts Profits by 50%
 Conclusion: HGT is a Sell
• Pro Forma 10-Year NPV
– $8.00/Mcf Price, 10% Discount, 5% Annual
Production Declines  $13.30/share
– $2.70 Dividend  13% Forward Yield
• Producing Fields Declining, Requiring
More Capital Investment
• Better Natural Gas/Oil Plays, If We Want
• Dividend is Red Herring

• And We’ll Pause for Questions…

 On to Regis Salons (RGS)…
• Operates or Franchises Over 10,700 Salons in North
America and Europe
– 5 yr. Total Salons Basically Flat, But Hides Shift in Mix
Away from Franchised (-45%)
– Salons Owned +38%, Aggressive Expansion Between
Construction and Purchases
• Also Beauty Schools and “Hair Restoration Centers”
• Target Consumer is Middle/Lower Class
– Point of Concern Given Discretionary Spending Trends

• Club Owns 225 shares = $3,500

 Regis (RGS) vs. S&P 500, YTD

Regis is down roughly in-line with the S&P 500 year-to-date. I believe Regis’ line of
business is more economically sensitive than the S&P 500 as a whole, and will likely
underperform going forward in this spending-constrained environment.
 How Regis Has Grown
• Concept Segment (Avg. Ticket, % Store Change, % Overall)
– Regis Salons ($39, <1%, 12.5%)
– Mastercuts ($18, +2%, 7.2%)
– Trade Secret ($26, +23%, 7.8%)
– Smartstyle/Wal-Mart Cost Cutters ($19, +75%, 25.8%)
– Strip Centers ($15, +53%, 41.1%)
• Note Concentration of Growth, Sales Dependence on Low
Ticket Concepts
– 75% of Stores Have Avg. Ticket <$20
– These Stores Generate 57% of Total Revenues
– Responsible for >90% of Revenue Growth in Last 3 yrs.
% Store Change based on 5 yr. difference in Regis-owned stores.
% Overall based on stores as % of all Regis-owned stores at 2008 FYE.
 Other Problems
• No Organic (Same-Store) Growth
– All Through Store Base Expansion
– Consistent Poor Comps  No “Good Leverage”
• Negative Tangible Book Value
– Value of a Salon Above Book?
• EPS Estimates Still Too High
– Only Down 15%
• Low Return Business (ROE < 10%)
 The Balance Sheet
• Equity of $976mm as of 6/30/2008
• Market Cap of $668mm at Friday’s Close
• Discount to Book? It Depends…
• Goodwill + Intangibles = $1.015b
– 45% of Total Assets
– Negative Tangible Equity
• Also, Current Ratio < 1.0
– More Liquid Liabilities Than Liquid Assets
 Balance Sheet, Part II
• Long-Term Debt Nearly Tripled Since 2004
• L-T Debt Maturity Schedule
– This Year: $217.5mm
– 1 to 3 yrs.: $128.3mm
• Credit Rating Downgraded to Speculative
– Can Regis Roll Over Borrowings?
• A Must to Continue Expansion  Grow Revenues
– If So, At What Cost? (c.f. Credit Spreads in
Earlier Presentation)
 Conclusion: RGS is a Sell
• Target Consumer Under Pressure
• Poor Long-Term Economics and Returns
– Questionable Strategy: Lever Up to Expand
During Economic Boom Time
• Margin of Safety (<1.0x Book) an Illusion
• Good Balance Sheets a Must Right Now
– Regis Does Not Have One

• Questions?