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Subject:  American Eagle & the Quality of its Cash Date:  3/5/2008  1:44 PM
Author:  hheiserman Number:  1447 of 1817

Since I have written about AEO a few times, I need to bring this item to your attention:

Part of my investment thesis for buying AEO was its cash-rich balance sheet, which results in a low enterprise value-free cash flow ratio.

Before I wrote about AEO for Real Money (and then posted the column then here), I asked AEO to describe the quality of their cash and short-term investments. I wanted to know if their liquid assets were cash-equivalents, or were some auction-rate securities (ARS). Management said all of their cash and equivalents were of the highest quality.

The problem with auction-rate securities is that no one wants to own them, given the today's credit contraction. I think the credit contraction will continue; we didn't get into this mess overnight, and we won't get out of it overnight, either.

In the link above we learn AEO has $338 million of auction rate securities, of which $134 million failed auction since mid-February. I do not have an auction timetable for the other $204 million, but probably in the next few months, given the short-term nature of these securities.

A write-down seems inevitable. And if management says some of its cash and equivalents are overstated, then net worth drops and enterprise value increases.

Because capital preservation is always my top concern, I intend to sell my position 24 hours after this post appears. My position is in a tax-deferred account, and the commission is nil. I want time to go over AEO from top-to-bottom, as we should do with all of our companies at least once a year. The 10-K should be out in early-May, so by then we should have a better sense of the quality of these ARS's, as well as how last year went.

I still like my original thesis for buying AEO, but I also recognize that one of the reasons why I bought the company is not as solid as I first thought. Even though I did my due diligence on the quality of AEO's cash, my research was not as thorough as it should have been.

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