Far From Finished at Finish Line

Finish Line (FINL), the mall-based retailer, has fallen on hard times lately and it has not gone unnoticed. The share price has declined about 30% due to depressing first and second quarter same-store sales declines of 7.2% and 6.6% respectively. The Company was recently issued a letter by Clinton Group (who currently owns 5.1% of FINL) encouraging the board to take action to increase shareholder value.

Today, we choose to highlight the following as initial steps that the board should do to enhance shareholder value: (1) eliminate the unfriendly shareholder corporate governance structure including the dual class voting structure, (2) commence a Dutch tender offer in conjunction with a modest senior debt financing, and (3) to the extent the share price continues to languish, engage a reputable investment banking firm to explore strategic alternatives including, but not limited to, a going private transaction or an outright sale of the Company.

The stock jumped 7.5% after the release of Clinton Group's letter but there still is money to be made. Finish Line currently carries a p/e of 11.67 which is historically low based on a five year average of 13.76. The book value is 1.38, cash flow is relative strong, and debt is minimal.

Finish Line trades at a discount to its closest competitor Foot Locker (FL). The following is another excerpt from the Clinton Group letter:

We believe that Finish Line represents an as good, if not better, leveraged buyout and/or management buyout candidate than Foot Locker given the Company's relatively lower valuation, strong cash flow generation, potential for a margin recovery story and diversified growth prospects. Over the last several years prior to calendar 2006, Finish Line experienced stronger revenue and earnings growth than Foot Locker. We also believe that the Finish Line shopping experience is truly a superior one given the stores' fresh decor, improving product mix and wide selection of non-footwear goods.

Finish Line will be an outstanding investment if Clinton Group is able to influence management to sell the company or take it private. As outlined in the letter, companies such as PETCO (PETC), Michaels Stores (MIK), and The Sports Authority are all companies which have been acquired for substantially more based on a value standpoint. A conservative 30% upside exists on a going private transaction and that percentage is probably even higher considering retail sale/private transactions are the current rage.

At this time I do not see the Company falling below $9.00 per share, which is a hefty fall from current levels ($12.43 per share). However, Finish Line may prove greater reward than risk for the patient investor.

FINL 1-yr chart:

Comments

[JosephFeeley]

Thanks for the post on FINL. I have made a fortune in this stock 3 different times and I am long again with a big position for round 4. Management is very shareholder focused and I would no be surprised if this company goes private. Book value is about $9 consisting of cash and inventory, and their inventory is lean. FINL is worth $18 if it is worth a nickel. A steal at these levels even with the current sales trends.

[Amit Chokshi]

I like FINL as well, although I liked it more around the mid $10s. I think Clinton Group ran a pretty weak analysis for their implied value, however, it was basically "unlocking value 101" with levering up the company to do some share buybacks and then hiring Bucketshop IBank to sell the company.

I agree that FINL will eventually go up and I like FINL more than FL, but CG's analysis was weak and suggested an inflated value. They used FL's comps which reflect a 20% command of the athletic footwear market, to suggest FINL should be valued at 6-7x EBITDA (FINL has 5% of the market), and then they go on to suggest FINL can go for 8.0x EBITDA in an LBO. If they plan to use Petco and MIK as comparable transactions they can also include BKRS as a public comp since it's a mall based footwear retailer (has a 2.6x EV/EBITDA multiple, guess that's why it didn't make sense for CG).

So, some would say why do you care if they can get a good pop in the stock price, it helps everyone, right? Well, I don't think pushing FINL into a going private transaction is worth it for public shareholders, especially those considering "long-term value" (another laughable term these days). Public shareholders would be leaving real money on the table because in my mind, an LBO firm won't pay more than 5.5x-6.5x for FINL because there are major expansion plans ahead for FINL in regards to Man-Alive and Paiva that will require real capex.

Let's run through some basic LBO math:
They offer 5.5x 2007 EBITDA of say $130mm = $716MM EV. Factor in the $50MM of net cash on the books results in about a $15.50 per share offer. In today's market, an LBO firm will want 70% debt, so they'd be looking at $500MM of financing which will probably carry a financing cost of 8% if not more. That results in about $40MM of cash interest per year. If the LBO firm wants to stop any expansion ideas for Man-Alive and Paiva, I guess they can curtail expansion and reduce capex so they can make room for that $40MM of cash interest but the key issue is that even in 2003 and 2004, FINL was spending over $55MM in capex per year. According to CG, an LBO firm would offer 8.0x EBITDA? That means a PE firm would put need $650MM-$780MM in debt, which would result in $50MM-$60MM+ in annual cash interest??? I really don't see a deal happening at that multiple. I see it much closer to $14-$17 per share

Secondly, if FINL was worth $18-$23 as a pure play footwear company as recently as 2005, as Man-Alive and Paiva really mature and grow, shareholders could arguably enjoy even stronger returns, $30+ per share, through potential spin-offs, sales of those other businesses. In my view, both of those businesses offer higher valuation potential than FINL once they get some good mass under them. Footwear has the lowest multiples around, I really think Man-Alive and Paiva could be valued independently at the 7-9x EBITDA, 15-18x P/E for MA and 9-11x, 20+x P/E for Paiva once they develop.

All an LBO firm will do is give shareholders a few extra bucks and then do all of this themselves, grow Man-Alive a bit more and then sell it off in a few years in a private deal or IPO, same with Paiva, and then refloat FINL, if they went through with an LBO. Other retailers like FL might be better LBO candidates because they are mature and don't have real expansion plans that require major capex, so you can lever it up, cut costs, and use the cash flow to cover financing. With FINL, they have just 5% of the athletic footwear retail market so have plenty of room to grow, plus I believe they are looking at $60-$80mm of capex related to FINL, Man-Alive, Paiva, and maintenance expenses based on my models for the next few years. With mature retailers you can basically limit capex to just store maintenance.

Plus, public shareholders shouldn't view CG as any savior, if you read the 13D you'll see them mention an appetite for participating in a go-private transaction. So public shareholders will think, gee $14-$17 per share, what a deal, and then the deal happens and CG will tender of course and then get some form of subdebt in the deal that will yield them 9-12% and will probably get warrants or some other equity component. They will essentially get a major return that will make the return public shareholders receive from tendering look like a money market account in comparison.

Just run IRRs on it. Say you buy FINL at $12.50 on 9/30/06, the co is sold and the deal is closed, shares are tendered by 6/30/07 (which would be very quick in terms of hiring an IB, getting the books out, bidding, winner, fairness opinion, and then deal close). Assuming you get one quarterly dividend payment, you're at an IRR of 27.9%.

Now assume you buy at $12.50 on 9/30/06 and there's no sale but the company fixes problems at FINL and successfully expands Man-Alive and Paiva. At year end 2009, just assume the shares are worth $28 per share. Not a major leap of faith when considering FINL went from about $5 to $20 in two years from 2003 to 2005. Factoring in dividend payments (and not accounting for any dividend increases, just the $0.10 annual dividend), you're at an IRR of 28.5%. Not a huge difference but if you believe in Man-Alive and Paiva, then the $28 is likely conservative. If you believe that management will continue to increase its annual dividend payment, the $28 is conservative.

Just my two cents.