As pointed out in the comments section, this analysis is fundamentally flawed. GuruFocus permitting, I'll leave it on the forum for future reference.
Thanks to those who pointed out where I was wrong. I have learnt something today.
With a market cap of $380 million and a reported net current asset value (NCAV) of $375 million, Radioshack (RSH) seems interestingly cheap. It’s not. If you read the footnotes, you will find:
1) Radioshack trades at a meaningful discount to NCAV.
2) The Company has a rock-solid balance sheet with significant excess cash.
This consistently profitable retailer isn’t just cheap, it is absurdly cheap.
Value and financial strength
As of March 31 2012, Radioshack reported current assets of $1665 million. Current assets consisted mainly of cash ($565m), inventories and receivables.
The company also reported $1280 million of total liabilities including $675 million of interest bearing debt. Of this, $375 million comes due next year. The rest ($300m) comes due in 2019.
From the 10-k:
In August 2008, we sold the 2013 Convertible Notes in a private offering. Each $1,000 of principal of the 2013 Convertible Notes was initially convertible, under certain circumstances, into 41.2414 shares of our common stock (or a total of approximately 15.5 million shares), which is the equivalent of $24.25 per share, subject to adjustment upon the occurrence of specified events set forth under terms of the 2013 Convertible Notes. Upon conversion, we would pay the holder the cash value of the applicable number of shares of our common stock, up to the principal amount of the note.
Last time I checked, 16 million shares were worth $60 million. This means the fair market value of that debt is now less than $75 million. If nothing bad happens (like the stock going up fourfold), $300 million of debt simply vanishes from Radioshack’s balance sheet. (375 m – cost to retire of 75 m). Alternatively, the CFO could pick up the phone tomorrow and offer bond holders $80 million. The only reason bond holders wouldn't take that deal is because they would be expecting a significant run-up of the stock.
If we account for the debt at fair value, total liabilities come down to $1 Billion.
1) Adjusted NCAV per shares comes in at 1665-1000/100 => $6.65
2) Radioshack has more cash in the bank ($565m) than debt ($300m + $75m).
3) No significant debt comes due before 2019.
Radioshack trades at a 40% discount to NCAV.
RadioShack has trouble keeping a dedicated CEO. In 2006, David Edmondson resigned over a falsified resume. Claire Babrowski took over as CEO for a few months. Then Julian Day, credited for the revival of Safeway and K-Mart, stepped in. Day downsized the company, closing nearly 500 stores and laying off 20% of the workforce.
Last year, Day handed the reins to James Gooch (previously CFO). Mr. Gooch (age 44) is also a former K-mart manager.
Mr. Gooch and his predecessors deserve credit for:
The smart but difficult decision to suspend the buybacks till the bonds come due. Barring a phenomenal run-up of the stock, that decision will probably generate at least $200 million in owner earnings next year.
Maintaining profitability through good times and bad.
The fact that Radioshack already is what other retailers hope to become (shop-in-a-shop).
At current depressed prices, Mr. Gooch has about half his annual income tied up in stock. In the relatively short period young Mr. Gooch has been at the helm, he has accumulated a significant amount of stock.
This is a competent and shareholder-friendly group of managers. It's certainly not the kind of management you typically find running a company trading at a 40% discount to NCAV. Management has been criticized for suspending the buy-backs. I believe the effect of this decison will become clear next year.
Buying back shares at current prices would be good for bond holders and bad for shareholders. The (nonlinear) math can get a bit complicated. In any case, as shares are retired by the company:
1) The number of shares bond holders get is increased (conversion rate adjustments of the convertibles)
2) The adjusted number represents a greater chunk of the remaining company.
3) The shares could run up causing the final cash-value of the convertible debt to rise.
In short, buying back shares aggressively, would mean handing the company to bondholders. The reverse too is true. Not buying back shares till after the convertibles come due means taking cash from bondholders and handing it to shareholders.
As it is, the management of Radioshack has paid owners roughly $1 billion of cold hard cash since 2007. That’s the amount Radioshack spent on buybacks and dividends; a significant amount of money for a company with a market cap of $380 million. This is as shareholder-friendly as it gets.
Business and competition
RadioShack is a leading US consumer electronics retailer. The company operates 4,500 company-owned stores in major malls and strip centers averaging 2,500 square feet per location. RadioShack's retail network also includes 1,300 wireless kiosks, 1,200 dealer outlets, and 200 company-owned stores in Mexico.
Revenue breaks down into mobility (51%), signature (31%), and consumer electronics (18%) products.
Two primary factors differentiate the company from its competition.
1) An extensive physical retail presence with convenient locations throughout the United States.
2) A trained sales staff is capable of assisting with the selection of appropriate products and accessories and, when applicable, assisting customers with service activation.
The bankruptcy of Circuit City has been offset by Amazon’s entry into the space. Though Radioshack’s service does provide some differentiation, investors are worried margins will be under pressure ging forward.
As a retailer, Radioshack compares favorably to Best Buy and in some respects to Amazon.
Gross margins are clearly higher and the company pays its suppliers in time. One way the competition juices its ROE is by paying suppliers later. This is a cheap form of leverage. Still, at Radioshack, ROE has historically been over 20%. 2011 saw a bad slump in earnings which depresses ROE.
The market is clearly extrapolating recent weakness far into the future. Historically, the only two years the company even came close to losing money are 2006 and 2011. These are the years they switched partners. In 2006 they ditched Verizon and in 2011 they took them back. These switches clearly depress net earnings by at least $100 million.
The Radioshack franchise has already been shown to work as a shop-inside-a-shop. This business model obviously has a positive effect on costs, asset turnover, ROA and ROE. Best-Buy and for that matter Sears are trying to transform themselves into something Radioshack already is.
In 2011, Radioshack ended its partnership with T-mobile in favor of a new one with rival Verizon. The switch caused a number of one-time charges to earnings. The same thing happened in 2006 when Radioshack ended its previous long-standing arrangement with Verizon. Such switches are obviously expensive. More of them would be bad for shareholders.
In five years, Amazon has taken a lot of market share in the electronics space. This puts pressure on gross margins. Unlike with books, I believe in the electronics space, there is a place for a retailer willing and able to select the best solution/product for a specific customer. That retailer is not Amazon.
After the bonds convert (August 2013), Radioshack is likely to reinstate its buy-backs.
The bonds now act as a poison pill (provisions against change of control). Once they convert, Radioshack becomes a target (pun intended).
Once the financial strength of the company is better understood, investors may no longer price the stock as if they are expecting the dividend to be cut.
At some point between now and September 2013, the company is going to record a massive GAAP profit. The market value of the fair value of the bonds will eventually be reflected in their book value. The only way this is not going to happen is if the stock quadruples before then. That's a risk worth taking.
It is possible bond holders hedged out the risk by shorting the stock. After the bonds mature (or are retired), the hedges will be removed. There may be significant covering of short positions.
A bear case
This is not a recommendation to buy or sell anything. I had no position in any of the stocks mentioned at the time of writing. Any and all questions welcome as usual.