UPDATE: FBR Fund Pushes Case That 99 Cents Only Offer Too Low

A mutual fund run by FBR Capital Markets Corp. (FBCM) on Friday pressed its case that the value of 99 Cents Only Stores (NDN) is "considerably in excess" of the $19.09-per-share buyout offer made last month by retail investor Leonard Green & Partners LP and the dollar-store chain's founding family.

In a letter to the 99 Cents Only board of directors, dated Friday and disclosed in a Monday filing with the Securities and Exchange Commission, the comanagers of the FBR Focus fund cited the company's opportunity for margin expansion, untapped real estate value, untapped pricing power and its potential to expand the chain, both in the four states it currently serves and beyond.

Further, the portfolio managers said 99 Cents Only would be valued at $21.75 to $23.50 a share using the valuation multiple of a transaction proposed in February by which billionaire Nelson Peltz's Trian Fund Management offered to buy larger competitor Family Dollar Stores Inc. (FDO). FBR noted that Family Dollar's board unanimously rejected the Peltz bid for "substantially" undervaluing Family Dollar.

Brian Macauley, one of the FBR Focus fund's managers, said in an interview that the fund has filed as an activist before, including last year joining a crowd that bemoaned the initial bid for Dynamex, a deal that ultimately closed at a price nearly 18% above the first offer. However, the fund isn't "actively inclined most of the time," and makes an exception only when it feels the fund's shareholders may not get what it feels is due them.

Before the company's ill-fated expansion attempts several years ago, most notably in Texas, 99 Cents Only enjoyed 13% to 15% operating margins, FBR said, and its margins are only now starting to recover. The California-based company also has "materially higher sales per square foot and store network density than any of its publicly traded dollar store peers," FBR added.

FBR said 99 Cents Only's land, buildings and building improvements are also worth more than the $257 million reported on its books in its most recent quarterly filing before depreciation. "The company, to date, has not pulled the levers to harvest this cash, but the shareholders should be fairly compensated if the opportunity is transferred to a new owner," the fund managers wrote. Macauley declined to say what he believes the real estate is worth, but noted that the $257 million doesn't include a further $249 million 99 Cents Only has spent on leasehold improvements, fixtures and equipment.

Following two price increases in recent years, including moving to sell items in increments other than 99 cents and a 1% increase to make prices 99.99 cents rather than just 99 cents, FBR said there is room for further pricing power.

Lastly, FBR said there is room to add new stores in its existing markets of California, Arizona, Nevada and Texas, plus the company has "almost open-ended potential for geographic expansion beyond."

A 99 Cents Only spokeswoman didn't return a phone call seeking comment.

The company on Monday morning it said it had selected three directors to evaluate both the current buyout offer and proposals or alternatives that might be available, and this special committee has retained Lazard as a financial advisor. Macauley said he is "pleased to see the process appears to off on the right first step," but he declined to say whether the fund feels the three directors and Lazard were the correct choices. In its letter, FBR said the committees must be completely independent from the founding Schiffer/Gold family and the advisors should be "top tier."

The FBR Focus fund owns about 3.8 million 99 Cents Only shares it bought for an average of roughly $10.06 apiece. The fund is highly concentrated, with only 17 stocks as of the end of last year, and 99 Cents Only represented more than 7.8% of the $773.4 million portfolio, according to fund tracker Morningstar. Its annualized return over the past 10 years is nearly 15%, putting it in the top 1% of 399 mid-cap growth funds over the same time, Morningstar said.

Shares of 99 Cents Only have traded above the going-private offer since it was made, fetching from $19.37 to $20.24 apiece since the buyout was announced on March 11, indicating Wall Street believes a higher offer is forthcoming. The stock was up 1.8% at $20.15 each at last glance Monday.

--By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com

Fbr Capital Markets Corp. (MM) (NASDAQ:FBCM)
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