There are few things worse than putting yourself up for sale and finding no takers. Such was the situation that discount retailer Big Lots, Inc. (NYSE:BIG) found itself in earlier this year.
In a business climate flush with excess capital and few safe places to put it, M&A activity increased significantly. This was no more true than in the discount retail industry with BJ’s Wholesale Club (BJ) agreeing to be taken private, Family Dollar (FDO) receiving interest from Nelson Peltz’s Trian Group (and flirtatious glances from Bill Ackman), and 99 Cents Only Store (NDN) getting an offer from Leonard Green Partners.
The foxes had entered the henhouse.
Big Lots’ spidey senses went off and, in sensing danger, management took the steering wheel and actively put itself up for sale, hiring big GunS, Goldman Sachs, to represent them. According to Bloomberg,
Big Lots Inc., the Columbus, Ohio- based discount retailer, is exploring strategic options, including a possible sale, and is working with Goldman Sachs Group Inc., said a person with knowledge of the situation. …Suddenly, BIG was the belle of the ball, with multiple private equity suitors rumoured to be asking for a dance. The market reacted favourably, with shares increasing from the mid $30s to the mid 40s.
“This company screens well as a candidate for a leveraged buyout because it has quality earnings, a lack of debt, they generate strong cash flow, and the management is high quality,” Joe Feldman, an analyst with Telsey Advisory Group LLC in New York, said today in an interview.
But alas, it wasn’t meant to be. In May, the company took itself out of the sale bin:
Discount retail chain Big Lots Inc. has decided not to sell itself after bids from private equity firms came in below the company’s expectations, people familiar with the matter said.Almost needless to say, upon news that the parties had retreated to their respective corners, Mr. Market did not react well and sent BIG shares down 17% over the next few days.
Big Lots had received interest from several buyout firms earlier this year, following which it decided to explore a sale, the people said. Two groups of private-equity firms—Bain Capital and TPG Capital, and Thomas H. Lee Partners and Advent International—had put in final bids for the discount retailer, they added.
But neither group was able to offer a price that met the expectations of Big Lots executives, people familiar with the matter said. The buyers weren’t willing to increase their offers, partly out of concern over Big Lots’ growth prospects because it hasn’t performed as well as dollar stores as the economy stabilized, the people said.
Let’s take a step back and look at BIG through the lens of a value investor and ask whether there just might be an opportunity here after all. First, let’s look at the company’s revenue and margins.
Big Lots, Inc - Revenues and Margins, 1999 - 1Q 2011
We see that the company has indeed been growing, and that (since 2005) the company’s margins have been strengthening quite nicely. Moreover, the company has achieved its revenue growth without discounting (more than usual). The following chart shows that the company’s sales per store have been largely flat for the last few years.
Big Lots, Inc - Store Metrics, 1999 - 2010
It is important to consider not only the company’s top line growth and margins, but also to put its operating performance into context. That is, has the company done a good job as steward of shareholder capital?
Big Lots, Inc. - Returns, 1999 - 1Q 2011
This paints a different picture of BIG. Revenues might not be skyrocketing, but the firm’s returns have been growing steadily. How’s that? First, the company generates strong free cash flows, generating net FCF of about $1.23 billion and CFO of $1.6 billion over the last five years (for context, this is relative to a current market cap of $2.45 billion):
Big Lots, Inc - Free Cash Flows, 1999 - 1Q 2011
Second, the company uses those free cash flows in a shareholder-friendly manner: buying back shares. And boy do they!
Big Lots, Inc - Shares Outstanding, 1999 - 1Q 2011
The company has reduced its share count by 35% since 2005, returning a whopping $1.25 billion in the process (all of that free cash flow mentioned above). Moreover, they have done this without loading up on debt:
Big Lots, Inc - Capital Structure, 1999 - 1Q 2011
As you can see, the company has used very little debt over the last five years. It has employed its free cash flow to paying off what little debt it did accumulate at times and repurchasing its own shares.
Before we get to valuation, let’s take a quick look at the company’s cash conversion cycle (Read about why this is important in these posts):
Big Lots, Inc. - Cash Conversion Cycle, 1999 - 1Q 2011
This shows a definite and positive trend, as the company has improved its inventory management and stretched its payables a bit longer. I like this and take this as a sign of high quality management.
In valuing BIG, I looked at different scenarios for sales per square foot of selling space, and number of stores. I then used historical averages for margins and worked my way through to an approximation of sustainable free cash flows, which I used as the basis for my valuation. I wasn’t thrilled by the potential amount of value destruction in my bearish scenarios. Even though I think the bear scenario is unlikely and I see good upside in both my bull and base scenarios, I focus on protecting myself first and letting the upside take care of itself. Conclusion: I will wait a bit longer. Maybe this is me being greedy, but there are so many great value opportunities in the retail space right now that I think I can afford the luxury of waiting for BIG to become a screaming buy.
What do you think of BIG?
Author Note: I am writing this post before the company’s Q2 results are out, though by the time this is published the results will likely have been released. I very much doubt a single quarter’s results would change my opinion one way or the other.
Author Disclosure: No position
Talk to Frank about Big Lots