October 20th Sell Pitches: Hugoton Royalty Trust (hgt) And Regis Salons (rgs)

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

• Liquidity is Key Now

Via Malkiel’s “Random Walk”

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?