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It seems to me that Footstar has some value in it. Now this is not a long-term play. I think you sell this company when it approaches the $12-15 range. It's a short arb play. Let's look at the negatives first though:

Store Closings
1. Losing 283 Kmart locations
2. Lost 650 Ames locations (was 4% of sales for 6 months ending June 30th)
So the Meldisco segment (51% of 01 sales) has gone from 6,765 stores at the end of 2001 to around 5,832 stores.
3. It's also possible they could have further store closings since the company also has 3,540 locations in Rite Aid, and 154 in Stein Mart. But Rite Aid seems to be improving and Stein Mart seems ok.

Accounting Issues
Management says they estimate they understated AP by $35 million though the asset side is ok. This is horrible news. But one thing that I find interesting is there was some insider buying in October before this came out. It would seem to me that insiders wouldn't be buying if they knew of bad news. So I think it's really just plain stupidity for what happened. We'll see if it gets worse.

Declining Revenues
The business the company is in is not the best; however, you CAN survive in this business. What's good to know is the company has no debt and is free cash flow positive, so it's going to take a lot of things to go wrong to seriously hurt the company.


Free Cash Flow Positive
Company is free cash flow positive which means it can sustain some rough periods.

No Debt
This is great news. I'm much more happy to run into a company like this at a low valuation when there is no debt and free cash flow.

Insider buying BEFORE accounting issue
One individual purchased 2,000 shares around 7.50 in October. He worked in the finance division, so this gives me some confidence that they were not expecting this accounting issue.

If you assume book value is approx $9, the company can earn $1.50 in 2003 (way below what the Street is saying), and free cash flow is around $1.00 then you get a company trading at .66x book value, 4x earnings, and 6x free cash flow. That's cheap. My only regret is not purchasing it closer to $3, but I hadn't seen it until today. I will say that if it does go to $3 and things haven't seriously changed, I'm going to purchase more.

So that's the story. Where do I think it's going? Well, 6-10x PE seems reasonable so I can see a $9-15 stock in a two year period. Plus why would anyone sell this company for less than 6x earnings? I can't think of a reason. It could go further up, but hey it's a short-term arb play in a ho-hum industry.


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