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Radioshack Corp: It Is Not a Real Net-net

November 13, 2012 | About:
Radioshack Corp (RSH) is engaged in the retail sale of consumer electronics goods and services through its RadioShack store chains. RSH's retail network includes approximately 4,700 company-operated stores in the U.S. and Mexico, 1,500 wireless phone centers in the U.S. and approximately 1,100 dealer and other outlets worldwide.

Valuation

RSH is a net-net trading at 0.61x P/NCAV and 0.34x P/NTA. 0.34x P/NTA is a new historical low for RSH; its previous historical low was 1.2x P/NTA during the global financial crisis in 2009. The cash on the books of RSH at $546.1 million is more than double its current market capitalization of $210.1 million. However, RSH is not in a net cash position.

Financial and Business Risks

RSH is highly geared with a gross debt-to-equity ratio of 113% and a net gearing of 31%. This does not take into account off-balance sheet liabilities such as operating leases and purchase obligations.

There are two types of leases: finance leases which appear on the balance sheet as financial liabilities, and operating leases which only show up in the income statement as rental expenses. This does not reflect economic reality. The most common form of operating leases is the rental of storefront by retailers. Retailers either borrow money to own the store front and repay the debt over the period of the loan, or pay fixed commitments in the form of rent over the period of operation. In reality, operating leases are no different from loans. Operating lease expenses should be capitalized to approximate the value of debt on the books.

RSH had operating lease obligations of $577.5 million as at Dec. 31, 2011, and purchase obligations of $509.9 million as at Sept. 30, 2012. Purchase obligations include product commitments and marketing agreements. The increase in purchase obligations from $333.2 million as at Dec. 31, 2011 is the result of inventory build-up and advertising commitments related to the fourth quarter holiday shopping season. Off-balance sheet liabilities add significantly to RSH's existing debt of $749.2 million on the books.

Business Quality and Capital Allocation

Gross margin for the trailing 12 months fell to 36.7% from a five-year average gross margin of 45.0%. Management attributed the fall in gross profit margin to a change in sales mix towards lower margin smartphones such as the iPhone. However, RSH's problem extends far beyond product mix and this is reflected in three consecutive quarters of losses.

RSH also announced that it had suspended its share repurchase program and dividend policy on Jan. 31, 2012, and July 25, 2012, respectively.

Conclusion

The calculation of net current asset value for RSH does not take into account the operating lease obligations of $577.5 million and purchase obligations of $509.9 million. If we deduct the discounted off-balance sheet liabilities from the net current asset value of $345.5 million, the net current asset value for RSH would in fact be negative.

The valuation case for RSH is weakened by the fact that it is not a real net-net and has a negative net current asset value. The prediction of turnarounds belongs in the realm of market gurus and stargazers. I will stay away from this stock.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


Rating: 3.1/5 (8 votes)

Comments

BEL-AIR
BEL-AIR - 1 year ago
Good detective work and also article Mark Lin....

Funny how so many on this site and others are saying how good RSH was and how cheap it was at $16 based on price to sales or some other magical valuation #... But I don't hear from them anymore now that the stock is at $2...

Anyways good work keeping others out of this obvious value trap.
marklin
Marklin - 1 year ago


Thanks BEL-AIR for your kind comments.

I will typically re-evaluate the asset valuation of net-nets by discounting cash, receivables and inventories based on a qualitative assessment and search for off-balance sheet liabilities. This has proven to be very helpful in weeding out "false net-nets".

pcai
Pcai - 1 year ago
It's great article.

May I ask in what scenario we should count operating leases and purchase obligations as liability, and what not ?

Thanks

marklin
Marklin - 1 year ago


Hi Pcai,

Thanks for your comments.

To understand the idea of adjusting for off-balance sheet liabilities, we have to go back to the accounting definition of a liability - an obligation of an entity arising from past events, the settlement of which may result in the transfer of economic benefits in the future.

With respect to operating leases, this is most relevant in the case of retailers which lease store space to run their retail operations. They have to sign non-cancellable lease contracts which require minimum rental payments and a penalty for early cancellation. This is no different from borrowing from banks to buy a shopfront.

With respect to purchase obligations, a common example is take-or-pay contracts. A company signing a take-or-pay contract has to honour its purchases, even if prices of raw materials or finished product head southwards.

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