In what’s become something of an annual tradition, this week I once again investigated an investment in Tandy Brands (TBAC, Financial). This time, however, I broke tradition and ended up buying a few shares. This post will discuss why I think an investment is cheap at today’s prices, but it all basically boils down to this: how much worse can things possibly get?
Note: I started writing this May 1st, with the price in the low $0.50s. I acquired a few shares there, though (unfortuantely) did not get nearly my fill. The price his risen quite a bit (to $0.80 per share) since then on no news that I can see, but given the extreme discount to asset value, I think the risk reward is still interesting, albeit diminished.
Let’s start by getting this disclosure out of the way: this investment is not for everyone. In general, I tend to like net-nets that are profitable, have the potential to be a decent businesses, and have good corporate governance. Tandy qualifies on exactly zero of those fronts. But the list of net-nets is drying up out there, and beggars can’t be choosers. That may be over exaggerating a bit, as the extreme risk / reward somewhat offsets the lack of traditional safety nets outside of asset value.
With that in mind, let’s dive in. Tandy designs and markets belts, gifts, and accessories. They do so under private label brands (ie Walmart contracts with Tandy to supply them cheap belts), licenses (ie Tandy makes belts for a well known brand, like Eddie Bauer), and their own in house brands. The business is, as you can imagine, a crappy one, as there’s no real barriers to entry here. Since there’s no real secret sauce to sourcing from Asia, the only differentiation in this business is price. Retailers are ferocious in driving out costs for private label brands and will happily drop Tandy for a competitor who offers a cheaper source; ultimately, the whole industry is going to earn their cost of capital.
So the industry is definitely poor. There’s our first check. And it’s really only the tip of the iceberg.
I’d be remiss if I didn’t follow up the terrible industry structure by noting that management is either 1) too arrogant or 2) too dumb to recognize the terrible industry. Check out their last investor presentation and read through their key strengths and investment highlights. To sum it up, management would have you believe that their company has the economics of Nike or Under Armour, not a commodity player.
What else is wrong here? Well, after promising a strong holiday season with “meaningful bottom line improvement” promised at the end of their first quarter, the second quarter / holiday season was such a disaster that Tandy 1) blew through their credit covenants, 2) had to hire a restructuring officer, 3) lay off 1/3 of corporate staff, and 4) look into new funding that will end with them paying 10%+ for a secured line of credit. So, yeah, it wasn’t exactly a blockbuster quarter.
Of course, the terrible stock performance hasn’t hurt insiders’ salary. As a matter of fact, at today’s prices, one year of the CEO’s salary ($350k) equals the market value of the entire stock ownership for all insiders plus the directors combined.
So we’ve got a company losing money with terrible insider incentive alignment that is having funding problems and competes in a crappy industry. What the heck is there to like here?
The first answer is asset protection. Even after all of their huge losses, inventory write downs, and restructuring charges, I’m still pegging NCAV value at ~$1.00 per share (the number could be a bit higher or lower depending on how the remaining charges come in, but it’s no where near the current stock price of ~$0.52.) Note that the NCAV number does not include the massive $46m the company has in NOLs. Those NOLs could be very valuable in a turnaround situation.
Second, while it doesn’t mean much given the size of the charges, after backing out one time charges, this company is still roughly EBITDA break even. Don’t rest your hat on it, but I think it shows that there is still potential here if all of the crappiness can be cut away.
But the biggest reason I’m seeing value in the stock is because it just doesn’t make sense for them to be public or even a standalone company anymore. Everyone’s incentives should be aligned for a sale of the company. It just makes too much sense.
Let’s start from the most important incentive: the CEO’s. While he owns almost no stock, the CEO has a very nice change in control agreement (see p. 28). Specifically, he gets two years salary plus his target bonus for that year, along with some other goodies. Let’s just say that the history isn’t littered with examples of CEOs who nearly bankrupt their company and need to have an outside restructuring officer brought in but were still kept by their board of directors. I think the CEO is highly incented to sell the company before he’s fired “for cause” and gets nothing in leaving.
Consider the restructuring officer as well (check his bio out here). He’s used to working with companies in or around bankruptcy. The easiest transition for him? Stabilize the company, sell it, and move on to the next gig.
Finally, just consider it from the entire management and insider team. There’s a decent chance of a bankruptcy here if the company doesn’t turn this around. No one (directors, executives, etc.) wants that black mark on their resume. These insiders have to consider their next jobs, and running a company into bankruptcy doesn’t exactly make for a nice calling card. Selling a company? That makes for a nice foot in the door!
A lot of times, the only thing standing in the way of a company getting sold is that directors want to keep collecting their cushy fees (and the fees here certainly are cushy). For example, those of you who have read Barbarians at the Gate know the directors are more concerned with keeping their auto insurance and pensions than realizing the highest shareholder value. But in a turn around situation, that’s off the table- if the turn around fails, those benefits go away anyway. The risk of the black mark strongly outweighs the “cushy” factor of continued high salaries and fees.
What if, even with the black mark factor in play, the officers and directors still want to keep making their cushy salaries (director salaries are also ridiculously high) and don’t want to sell? I don’t think it will be in their hands for long; the shareholder base is quite fragmented and just begging for an activist to come in and push for a sale (at this point, an activist would probably realize a nice return from liquidating as well, but as we will discuss below a sale would be much more valuable). I could also see a competitor launching a hostile offer for Tandy if management refuses to sell.
Does a merger make sense? Absolutely. My first rule in any merger is “getting rid of the idiot management team that is running the company into the ground has great synergy value,” and that rule certainly applies here. However, there’s more than that here. Mergers in this space make sense. The gross margins are decent, so combining two competitors can allow them to leverage SG&A costs, get into each others distribution channels, and realize some real synergies.
And there’s reason to believe Tandy is ripe for acquisition. The main reasoning behind this is that their most direct competitor, Swank, was acquired by another competitor, Randa, last year (seemerger proxy here, TBAC is actually listed as a comp on page 46). Amusingly, I actually played the merger (the company received a superior bid that ultimately fell through).
Randa’s thinking behind Swanks’ merger was likely pretty simple. Randa acquired Swank for ~65M EV. Swank’s annual sales were ~$140m with 30%-ish gross margins (they were projecting 32% going forward w/ about 28% trailing) and ~$35m in SG&A, resulting in EBITDA of ~$10-11m (projections on page 51). With little capex, EBITDA was roughly equal to EBIT.
Randa probably thought this: we’re getting a fair price on the deal. If we can cut out any of that SG&A, the price will look like a bargain. If we can push any of our current products through their sales channels or vice versa, the price will (again) be a bargain. If none of that works out, we’ve made a value neutral acquisition.
Let’s consider the similarities between Swank and Tandy. They’re direct competitors. Swank’s annual sales were a hair under $140m; Tandy’s are around $120m. Swank’s gross margins were 30%-ish; Tandy’s gross margins in fiscal 2012 were a hair under 32% and, even after the disastrous holiday season, trailing twelve month margin is just a bit under 30%.
In other words, Swank and Tandy are almost directly comparable. And Swank got acquired for almost 0.5x sales. It’s true that they weren’t in as poor of a balance sheet / turn around situation as Tandy is now, so maybe Tandy gets acquired for a discount. I think Randa would be licking their lips to acquire Tandy for 0.3-0.4x sales. What would that price imply for today’s shareholder?
Trailing twelve month sales for Tandy come in at $119m. They were are $117m in 2012 and $123m in 2011, so I think that’s a decent number. That would imply, at a distressed multiple of 0.3x sales (well below the Swank multiple!) an EV of roughly $36m. Tandy has a credit line of $11m (there could be some synergies here- their new credit line is expensive. A buyer could refinance the line at a much lower rate!), and I’m going to knock another $5m off for restructuring and severance payments (this is actually a good deal higher than their forecasts excluding impairment charges). That would leave us with equity value leftover of $20-21M. With 7.1m shares outstanding, that would be a stock price of almost $3 per share! (note that some options would come into play at those levels, slightly diluting the number, but i’m not going to bother adjusting given how much higher that number is that today’s price).
Could there be an argument for Tandy’s value as a standalone business? Sure, anything’s possible- Swank was earning $10m in EBIT on $140m in sales per year. If Tandy could do that margin level at today’s sales levels, which seems entirely reasonable, they’d be earning over $8.5m in EBIT per year. Compare that to today’s EV under $15m and you’d have yourself quite a bargain.
Still, I think the most likely outcome is a buyout. It just makes too much sense from everyone’s stand point.
It’s an interesting risk reward situation that I think (ultimately) makes a ton of sense. Do I want 20% of my portfolio in it? Absolutely not! But I’m happy to put a small piece of my portfolio in it and see what happens. If you told me this is a zero three years from now, I’d believe you. If you told me this is a four or five bagger a year from now; I’d again believe you. I’m investing and hoping for the latter, but even if the former happens, I think it’ll be a case of good process / bad outcome!
Disclosure: Long TBAC
Note: I started writing this May 1st, with the price in the low $0.50s. I acquired a few shares there, though (unfortuantely) did not get nearly my fill. The price his risen quite a bit (to $0.80 per share) since then on no news that I can see, but given the extreme discount to asset value, I think the risk reward is still interesting, albeit diminished.
Let’s start by getting this disclosure out of the way: this investment is not for everyone. In general, I tend to like net-nets that are profitable, have the potential to be a decent businesses, and have good corporate governance. Tandy qualifies on exactly zero of those fronts. But the list of net-nets is drying up out there, and beggars can’t be choosers. That may be over exaggerating a bit, as the extreme risk / reward somewhat offsets the lack of traditional safety nets outside of asset value.
With that in mind, let’s dive in. Tandy designs and markets belts, gifts, and accessories. They do so under private label brands (ie Walmart contracts with Tandy to supply them cheap belts), licenses (ie Tandy makes belts for a well known brand, like Eddie Bauer), and their own in house brands. The business is, as you can imagine, a crappy one, as there’s no real barriers to entry here. Since there’s no real secret sauce to sourcing from Asia, the only differentiation in this business is price. Retailers are ferocious in driving out costs for private label brands and will happily drop Tandy for a competitor who offers a cheaper source; ultimately, the whole industry is going to earn their cost of capital.
So the industry is definitely poor. There’s our first check. And it’s really only the tip of the iceberg.
I’d be remiss if I didn’t follow up the terrible industry structure by noting that management is either 1) too arrogant or 2) too dumb to recognize the terrible industry. Check out their last investor presentation and read through their key strengths and investment highlights. To sum it up, management would have you believe that their company has the economics of Nike or Under Armour, not a commodity player.
What else is wrong here? Well, after promising a strong holiday season with “meaningful bottom line improvement” promised at the end of their first quarter, the second quarter / holiday season was such a disaster that Tandy 1) blew through their credit covenants, 2) had to hire a restructuring officer, 3) lay off 1/3 of corporate staff, and 4) look into new funding that will end with them paying 10%+ for a secured line of credit. So, yeah, it wasn’t exactly a blockbuster quarter.
Of course, the terrible stock performance hasn’t hurt insiders’ salary. As a matter of fact, at today’s prices, one year of the CEO’s salary ($350k) equals the market value of the entire stock ownership for all insiders plus the directors combined.
So we’ve got a company losing money with terrible insider incentive alignment that is having funding problems and competes in a crappy industry. What the heck is there to like here?
The first answer is asset protection. Even after all of their huge losses, inventory write downs, and restructuring charges, I’m still pegging NCAV value at ~$1.00 per share (the number could be a bit higher or lower depending on how the remaining charges come in, but it’s no where near the current stock price of ~$0.52.) Note that the NCAV number does not include the massive $46m the company has in NOLs. Those NOLs could be very valuable in a turnaround situation.
Second, while it doesn’t mean much given the size of the charges, after backing out one time charges, this company is still roughly EBITDA break even. Don’t rest your hat on it, but I think it shows that there is still potential here if all of the crappiness can be cut away.
But the biggest reason I’m seeing value in the stock is because it just doesn’t make sense for them to be public or even a standalone company anymore. Everyone’s incentives should be aligned for a sale of the company. It just makes too much sense.
Let’s start from the most important incentive: the CEO’s. While he owns almost no stock, the CEO has a very nice change in control agreement (see p. 28). Specifically, he gets two years salary plus his target bonus for that year, along with some other goodies. Let’s just say that the history isn’t littered with examples of CEOs who nearly bankrupt their company and need to have an outside restructuring officer brought in but were still kept by their board of directors. I think the CEO is highly incented to sell the company before he’s fired “for cause” and gets nothing in leaving.
Consider the restructuring officer as well (check his bio out here). He’s used to working with companies in or around bankruptcy. The easiest transition for him? Stabilize the company, sell it, and move on to the next gig.
Finally, just consider it from the entire management and insider team. There’s a decent chance of a bankruptcy here if the company doesn’t turn this around. No one (directors, executives, etc.) wants that black mark on their resume. These insiders have to consider their next jobs, and running a company into bankruptcy doesn’t exactly make for a nice calling card. Selling a company? That makes for a nice foot in the door!
A lot of times, the only thing standing in the way of a company getting sold is that directors want to keep collecting their cushy fees (and the fees here certainly are cushy). For example, those of you who have read Barbarians at the Gate know the directors are more concerned with keeping their auto insurance and pensions than realizing the highest shareholder value. But in a turn around situation, that’s off the table- if the turn around fails, those benefits go away anyway. The risk of the black mark strongly outweighs the “cushy” factor of continued high salaries and fees.
What if, even with the black mark factor in play, the officers and directors still want to keep making their cushy salaries (director salaries are also ridiculously high) and don’t want to sell? I don’t think it will be in their hands for long; the shareholder base is quite fragmented and just begging for an activist to come in and push for a sale (at this point, an activist would probably realize a nice return from liquidating as well, but as we will discuss below a sale would be much more valuable). I could also see a competitor launching a hostile offer for Tandy if management refuses to sell.
Does a merger make sense? Absolutely. My first rule in any merger is “getting rid of the idiot management team that is running the company into the ground has great synergy value,” and that rule certainly applies here. However, there’s more than that here. Mergers in this space make sense. The gross margins are decent, so combining two competitors can allow them to leverage SG&A costs, get into each others distribution channels, and realize some real synergies.
And there’s reason to believe Tandy is ripe for acquisition. The main reasoning behind this is that their most direct competitor, Swank, was acquired by another competitor, Randa, last year (seemerger proxy here, TBAC is actually listed as a comp on page 46). Amusingly, I actually played the merger (the company received a superior bid that ultimately fell through).
Randa’s thinking behind Swanks’ merger was likely pretty simple. Randa acquired Swank for ~65M EV. Swank’s annual sales were ~$140m with 30%-ish gross margins (they were projecting 32% going forward w/ about 28% trailing) and ~$35m in SG&A, resulting in EBITDA of ~$10-11m (projections on page 51). With little capex, EBITDA was roughly equal to EBIT.
Randa probably thought this: we’re getting a fair price on the deal. If we can cut out any of that SG&A, the price will look like a bargain. If we can push any of our current products through their sales channels or vice versa, the price will (again) be a bargain. If none of that works out, we’ve made a value neutral acquisition.
Let’s consider the similarities between Swank and Tandy. They’re direct competitors. Swank’s annual sales were a hair under $140m; Tandy’s are around $120m. Swank’s gross margins were 30%-ish; Tandy’s gross margins in fiscal 2012 were a hair under 32% and, even after the disastrous holiday season, trailing twelve month margin is just a bit under 30%.
In other words, Swank and Tandy are almost directly comparable. And Swank got acquired for almost 0.5x sales. It’s true that they weren’t in as poor of a balance sheet / turn around situation as Tandy is now, so maybe Tandy gets acquired for a discount. I think Randa would be licking their lips to acquire Tandy for 0.3-0.4x sales. What would that price imply for today’s shareholder?
Trailing twelve month sales for Tandy come in at $119m. They were are $117m in 2012 and $123m in 2011, so I think that’s a decent number. That would imply, at a distressed multiple of 0.3x sales (well below the Swank multiple!) an EV of roughly $36m. Tandy has a credit line of $11m (there could be some synergies here- their new credit line is expensive. A buyer could refinance the line at a much lower rate!), and I’m going to knock another $5m off for restructuring and severance payments (this is actually a good deal higher than their forecasts excluding impairment charges). That would leave us with equity value leftover of $20-21M. With 7.1m shares outstanding, that would be a stock price of almost $3 per share! (note that some options would come into play at those levels, slightly diluting the number, but i’m not going to bother adjusting given how much higher that number is that today’s price).
Could there be an argument for Tandy’s value as a standalone business? Sure, anything’s possible- Swank was earning $10m in EBIT on $140m in sales per year. If Tandy could do that margin level at today’s sales levels, which seems entirely reasonable, they’d be earning over $8.5m in EBIT per year. Compare that to today’s EV under $15m and you’d have yourself quite a bargain.
Still, I think the most likely outcome is a buyout. It just makes too much sense from everyone’s stand point.
It’s an interesting risk reward situation that I think (ultimately) makes a ton of sense. Do I want 20% of my portfolio in it? Absolutely not! But I’m happy to put a small piece of my portfolio in it and see what happens. If you told me this is a zero three years from now, I’d believe you. If you told me this is a four or five bagger a year from now; I’d again believe you. I’m investing and hoping for the latter, but even if the former happens, I think it’ll be a case of good process / bad outcome!
Disclosure: Long TBAC
