|Shares Out. (in M):||15,851||P/E||14.0||10.9|
|Market Cap (in $M):||136||P/FCF||0||0|
|Net Debt (in $M):||-33||EBIT||0||0|
And now for my second negative comping retail idea of the night: Long BBW.
Average Daily Trading Volume: $1.72mm
One can hardly open a financial website or newspaper or have a conversation on any given day without being reminded that for retailers (or any business) not named Amazon, things can only get worse, or much, much worse as Amazon will aggressively come after them with no regards for profits, no matter the industry. Have we reached peak hysteria surrounding Amazon? I can’t be sure as I thought we reached peak TSLA hysteria four years ago but it intensifies by the hour. We can, however, hopefully take advantage of the panic induced by Bezos within the specialty retail space by buying companies that are truly more insulated from Amazon (...I think...err..hope...). I believe Build-a-Bear is one such retailer. “Experiential” has become the buzzword du jour within retail, and yet despite BBW being a quintessential experiential retailer with an interactive process of stuffing your own teddy bear/animal, it’s stock is very out of favor. With 90%+ brand recognition across North America, and having been written up a few times on the VIC before, most likely everyone reading is at least familiar with what BBW is. Everdeen’s write-up of BBW (the last one on VIC ~5 years ago) stated: “The company has a franchise that would be difficult to replicate and offers an experience that is essentially Internet-proof.” The stock is up roughly 100% over that time (not a great IRR), however, it did rise to a high of $22+, so despite languishing for the first six months or so, it was a huge winner from there. At the risk of repeating the same theses posted to the VIC then, I’ll try to focus on what has changed and why now may be the time to take another look at BBW on the long side for small cap value investors.
Much has transpired since that last write-up, most of it unambiguously positive, at least up until December 2016, when traffic fell off a cliff and BBW posted a -8.3% Q4 same store sales comp print, despite positive comps through October and November. Over the last several years BBW has closed many unprofitable stores, increased merchandise margins by a full 9%, and went from having ~22% of stores being unprofitable to 5% currently.
Here is a chart of quarterly SSS back to 2004:
I can’t sugarcoat it, it has not been a pretty picture. The Q4 call is chock-full of excuses from management. Here are SSS comps on an annual basis:
Despite the long string of negative comps, BBW has remained EBITDA positive every single year. When no turnaround seemed in sight and there was little hope, the stock briefly went sub-1x EBITDA in February 2009 (oh, don’t you miss those days? Sort of…) and languished as low as 1.5x EBITDA even many years after the financial crisis even as a turnaround had then started to sink its teeth. The average and median EBITDA multiple over the last ten years is 4.8x:
Here is a summary of some key metrics:
Strategic Alternatives/Review Still underway
Along with their Q1 results, on May 3rd, 2016 the company announced they had hired Guggenheim to explore a sale (the enterprise value is down almost $90 million from the time of that announcement). Lo and behold, here we are 10 months later and no transaction has transpired and the Q4 print was abysmal. At this point pretty much no one is expecting anyone to buy them out. There were many “false positives” that had me believing BBW would attract a healthy bid prior to reporting Q4. The false positives were Canadian toy company Spin Master expanding their revolving credit line by $230 million (just the right amount to pay a nice premium on BBW, I thought), announced December 21st, 2016, with the explicit intention of using the credit line for M&A in the near term. Secondly, just two weeks later BBW cancelled their appearance to the ICR Retail Conference the second week of January, while this auction process was ongoing, despite attending the previous three years in a row. Another thing was the company's amendments of the executive compensation plan shortly before announcing they were exploring a sale, including significantly increasing severance pay upon change in control. Additionally I had just bought my two nieces and nephew the Build-a-Bear at home kit and they went nuts over it and continued to play with the miniature stuffer for many days after initially making the bear (putting play-doh in it and cranking it out, like a pasta-maker). My limited sample size of channel checks showed this item was not merchandised well at Toys R Us (e.g. only in the back and available upon asking store employees), or repeatedly out of stock/unavailable.
It is difficult to pick the right transaction comps for a potential BBW valuation in a sale, but it is also difficult to find anything remotely related such as toy companies or specialty retailers getting bought out for less than 8x EBITDA (this would give 70%+ upside).
After two terrible Q4/Holiday selling periods in a row, does this signify the business is in structural and secular decline, or is the weakness temporary and can BBW stem the SSS declines and negative operating leverage that crushes declining retailers? There are a few silver linings that signal not all hope is yet lost, though many are hard to perfectly quantify.
Stock value is about the future…so what’s to like?
Store base overview
BBW has 438 stores total. They’ve hit a new peak in franchised locations at the end of 2016 of 92 stores. I believe they are significantly underpenetrated in terms of international locations. They are currently only in 11 different countries. The co-owned international stores are significantly more productive than domestic ones, with sales psf consistently 30-40% higher internationally, which bodes well for future international franchise growth.
BBW’s Average Unit Volume has dropped over time and unit economics have become worse. Sales per store is ~$1.03mm with ~19% 4-wall EBITDA margins. Each new store opening cost anywhere from $600,000 to $780,000. So pre-tax profit contribution is ~$196k on an investment of $780k, or ~25% ROI. Management cites a lower cost of new stores going forward as they’ve shifted sourcing of fixtures to China for some savings. An additional new initiative highlighted and discussed in the latest earnings conference call is a shift of new store openings to “Concourse Stores”—smaller store formats in non-traditional locations, such as out in the “concourse” of a mall, e.g. the large walkway spaces/common area of a mall where you sometimes see a Starbucks or QSR.
Management highlights these Concourse stores as being more flexible in lease terms, e.g. 3-year maximum lease terms with lower rents, and costing one-half or less than a traditional store opening, yet achieving >50% of the sales volume in pilot locations. The idea of all these smaller store formats doesn’t thrill me, but it is also not a bad option if they achieve management’s targets. Additionally, as they let leases of traditional stores with the mall lapse and convert some to the smaller Concourse format, this should free up significant working capital in inventory creating a one-time FCF windfall. Days of Inventory outstanding has been rising and has a lot of room to come down.
Currently 2017 guidance is to open 20-25 new stores, with 15 in the new Concourse format, remodel 20-25 stores in the Discovery Store format, close 5-10, and extend 55-65 leases. All in they guide to end 2017 with 360 co-owned stores. I would push them to open fewer stores, especially any traditional format stores within enclosed malls, and let a lot more of the leases roll-off without extending. The good news is that 50% of the North American stores have leases expiring within the next three years, leaving them a lot of optionality on continuing the turnaround with the ability to pruning the worst stores and have net store shrinkage. In my opinion they should aggressively be closing any marginal stores that are trending in the wrong direction.
Here is a table of annual capital expenditures:
They are in a period of heavy cap-ex. Some of it is admittedly defensive in nature (some Discovery store format remodeling to prevent further comp collapse), but the large majority is pure growth cap-ex from opening new stores and spending on IT to boost eCommerce capability, some of which is more one-time in nature. Capex guide for 2017 is $20-25 million (75% for new stores and store remodels, and 25% for IT infrastructure). I think they will eventually come out below the low end of this guidance due to shareholder pressure. Excluding 2015 and 2016 when they opened 35 and 32 stores, average cap-ex from 2010-2014 was just $14.7 million, despite still opening an average of 21 stores per year those five years. If they opened zero new stores I believe cap-ex could easily be less than $10 million on maintenance cap-ex (e.g. 2009, still opened 11 stores and spent just $8mm). Operating cash flow average from 2010-2015 is $23.14 million. Again though to reiterate the gross margins are much higher now than in 2009/2010/2011, so the annually operating cash flow from the more recent years may be more representative of current steady-state.