First, some background. CCA is involved in the marketing and sales of several brands. They own or have the exclusive license to many brands which I would consider mostly “B” brands, and they include (directly from their 10-K) “Plus+White” (oral health-care products), “Sudden Change” (skin-care products), “Nutra Nail” and “Power Gel” (nail treatments), “Bikini Zone” (pre and after-shave products), “Mega – T” Green Tea (dietary products), “Mega – T” chewing gum (anti-oxidant dietary product), “Hair Off” (depilatories), “IPR” (foot-care products), “Solar Sense” (sun-care products), “Wash ‘N Curl” (shampoos), “Cherry Vanilla” and other Vanilla fragrances (perfumes), “Lobe Wonder” (ear-care product), Pain Bust*R II (topical analgesic) and “Scar Zone” (scar diminishing cream).
The first concern is major customer concentration. Walmart (NYSE:WMT) makes up 41% of sales and Walgreens (WAG) makes up 13%. Other big retailers like CVS and Dollar General come in in the 3-5% range. The loss of any of these customers could be tragic for the company. This is definitely a non-trivial risk- at the start of 2009, Wal-Mart briefly stopped carrying the Plus-White brand in stores and CCA lost $5m of sales. Wal-Mart eventually re-picked up the brand, but the loss of WMT would likely cripple the company.
However, outside of that risk, the company’s financials are excellent. CCA has cash and marketables of over $13m against no debt and total liabilities of ~8.5m. Net working capital (including marketable securities) comes in just under $25m versus a current market cap of $34m.
Finding the company’s true earnings power takes a bit of digging. The company reported an EBT loss of $2.36m in 2010; however, most of this was from a huge litigation charge of $2.24m. Since that appears to be a one time deal and there are no on-going litigation cases, I think we can safely add that back and say the company basically broke even in 2010.
I think the best way to look at CCA’s earning power is to use an adjusted form of EBIT. To do this, I start off with their reported EBT, then I add back their interest expense, litigation expense (2010 only), transaction expense (2007 only, $718k), and any gains from downward adjustments for doubtful accts (each of the past six years except 2008 and 2005). Note that this last adjustment may be a bit unfair- it means they had previously understated their earnings power, and I am penalizing them when they report the losses from doubtful accts but not giving them the benefit when they reverse extensive expensing. Still, it’s a small item and shouldn’t make a difference.
When I do this, I get the following numbers – 2010 = -$248k, 2009 = $5.62m, 2008 = $2.48m, 2007 = $10.32m, 2006 = $8.85m, 2005 = $7.13m. All told, the numbers average out to $5.69m in average adjusted EBIT for the past six years. For a company with a market cap of $34m and an EV of $21m…. well, that’s ridiculously cheap. If you think the company’s future earnings will look anything at all like they did in the past, then it’s a screaming buy at these prices. I’m not going to bother to post pre-tax ROIC (EBIT / tangible invested capital) because it’s excellent and I’m about to make a big adjustment, so you’ll just have to trust me that it’s very, very good- more than 50%.
So let’s start talking about that adjustment. Until this year, the company was run by its two founders (it’s now run by one of the founder’s sons). Their compensation was absolutely ridiculous, to say the least. Over the past six years, revenue averaged $58.9m per year. Adjusted EBIT averaged (as mentioned before) $5.69m, or just under 10% of revenues. Executive compensation for just the top two execs (the founders) averaged $2.66m per year, or almost 5% of revenues. If that seems excessive to you, it’s because it is excessive. If we add it all together, we get a figure that I’m calling EBIT + founder’s comp that averaged $8.35m for the past six years.
Now, this year the founders retired, and they were replaced by one of the founder’s sons. He will make ~$500-600k per year, so just the two founders retiring seems to have stripped out more than $2m of cost from the organization!
So there’s all your positives. Relatively stable industry (consumer brands). Strong distribution through almost all national chains may allow for accrettive acquisitions (the pfizer model, where you buy a product and use your much larger distribution to expand sales rapidly). Currently somewhat depressed earnings, but incredibly cheap if they manage to get back to where they were. Ridiculously strong balance sheet, very nice dividend. Potential buyout target for a P/E firm (they got a buyout offer in 2007, discussed below) or larger brand firm.
However, now we come to the negatives. And the negatives are big enough that they’ve so far kept me from investing in the company despite it’s apparent ridiculous cheapness.
The first concern is earnings are depressed right now. TTM adjusted EBIT comes in negative, and revenue is declining. A potential investor needs to decide if this is temporary and/or cyclical or permanent. I tend to lean towards the first, but it’s a decision you need to make. There also are some concerns over some defective / recalled products that you’d need to get comfortable with, as well as recent cut backs in advertising, but I’m also going to ignore those because neither are my biggest concern.
Instead, my biggest concern is management has historically treated the company like a personal piggy bank and shown a complete disregard for shareholders. Here’s a quote straight from the founders former contract “During the employment period, the contracts had provided for a base salary which commenced in 1994 in the amount of $300,000 (plus a bonus of 20% of the base salary), with a year-to-year CPI of 6% increase, plus 2.5% of the Company’s pre-tax income plus depreciation and amortization plus certain fringe benefits including the cost of auto expenses, and health insurance.” Later, they amended it to increase the base salary by $100k and EBITDA to “earnings before income taxes, plus depreciation, amortization and expenditures for media and cooperative advertising in excess of $8,000,000.”
Among the best contracts for management I’ve ever seen. I mean, cost increases of 6% a year weren’t enough??? They had to raise their salary by an extra $100k??? And the ebitda portions…. WOW!!!
The founders retired effective this year. As part of their retirement, they agreed to stay on as “consultants” and received a 5 year contract paying each of them ~$650k per year for the next 6 years, with annual inflation of 6%. In the case of a takeover, that becomes a lump sum payment. In other words, a potential acquirer is looking at shelling out (at this point) over $6m, or ~1 years worth of EBIT, to two consultants (there are also some big payouts to current execs, though not nearly this big). These are exactly the problems that prompted Biglari to seek a board seat.
Then you have to worry about the dual share class. The founders control the company through A shares, which represent ~15% of the shares outstanding but control 4 of the 7 board seats. They supposedly have equivalent economic interest to the shares you and I could buy on the open market.
But management doesn’t seem to believe that. CCA agreed to be bought out in 2007. Common shareholders were to recieve a price of $12 per share, while A shares (read = mgmt) got $14.50. The buyout fell through because of financing issues, but it’s instructive that mgmt was willing to sell shareholders out short like that (also instructive that they let someone sign a letter of intent instead of a definitive agreement with a break up fee!). Read more about the situation here and in this activist filing.
Overall, I really want to invest in the stock. It seems to me that, despite depressed current earnings, there’s a ton of upside and a lot of margin of safety here. Consumer brand companies are excellent targets for both financial and strategic buyers and rarely, if ever, deserve to trade for less than half of sales. But my big concern is management seems intent on taking that margin of safety for itself and not leaving any for shareholders. If you really believe Biglari can right the ship, then CCA is probably a great buy. But this is a very small position for a man who is taking a lot of activist positions. Maybe he’s content to sit on the board and let mgmt steal a ton for itself as long as they leave a little for shareholders. Maybe mgmt is just too entrenched for him to over come- they control the board; they don’t have to listen to him. Even if one of those scenarios are the case, CCA might still be a buy, but I think my current holdings are cheaper. Maybe if some cash frees up in my portfolio (GKK just filed the proxy for electing their preferred director…..) and the shares stay cheap I’ll pull the trigger. Until then, I’m on the sideline.
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