Systemax (NYSE:SYX), best known for its TigerDirect.com internet retailing operation, has had an enormous run recently. After trading in a narrow range for over 3 years, it began a meteoric rise of over 150% in just weeks this fall.
On October 11, 2006, Systemax announced that its 2nd quarter - which was due August 15th for the quarter ended June 30 -- would be late. again. This is no surprise -- the company just came out of a restatement period in which their own auditor gave a list of warnings about internal controls.
Also it comes as no surprise that on September 7, 2006, Michael J. Speiller, the Company's Vice President, Controller and Principal Accounting Officer, notified the Company that he was resigning (replaced by a gentleman whose last gig was a public company that went BK).
The reason for the run-up was an apparently exceptionally good quarter's results, which got it included in the Investors' Business Daily "Top 100" list. This list, derived from simple quant formulas, gives a lot of weight to relative price strength of the stock. Price strength, which only measures momentum, not investment quality, can be a risky "self-fulfilling prophesy".
In the last quarter reported, (March 31) net income was up $17.5 million yet cash decreased by $20 million..what gives?
The reason for this is the increase in inventory, which by their own admission, is not a good thing.
From the March 31 10Q:
"Inventory levels increased $48.5 million in North America, primarily in our computer products segment, as a result of bulk purchases of selected items offered at favorable pricing made during and at the end of the quarter"
Yet, we read from a previous filing -- the Dec 31 10-K:
"A substantial portion of our inventory is subject to risk due to technological change and changes in market demand for particular products. If we fail to manage our inventory of older products we may have excess or obsolete inventory"
Tech inventory is generally an unfavorable thing to be heavily invested in. If you're bulked up for Christmas, its understandable, but we're talking March 31 here.
The Stinking Gun
The financial management issues swirling around SYX would be bad enough if its business was squeaky clean. But unfortunately, the problems here go much deeper.
If you submit nearly any tech product to a "shopping" search on the internet, chances are TigerDirect.com will pop up as one of the lowest price, if not THE lowest price vendor.
How do they do this?
Most of the time, it's because they have offered a lowball sales price which is net of one or more rebates. Rebates are a very controversial topic in retailing these days. Consumers hate them, and there is so much abuse of the system that Best Buy and Office Max are on a strategic path to eliminate them from the big box world by next year.
The problem is so bad, the FTC has issued a special warning about rebate problems.
But a more sinister problem lurks. To see what we mean, enter the search string [Tigerdirect and rebate and complaint] in Google. and start reading from among the 54,000 hits.
You will find at your fingertips a litany of consumer abuse just waiting for a State's Attorney General to step up to the plate. A common pattern:
- Customer buys from Tigerdirect induced by an apparent low price derived from a rebate
- Customer follows complex directions and submits proof of purchase and rebate claim
- Rebate claim is denied or ignored
- Company refuses to return original proof-of-purchase
- Company ignores complaints
- Customer service makes excuses, redirects the inquiry, and generally fails to resolve the complaint
- Customer finally gives up without obtaining rebate
There are many troubling aspects to these reports. First of all, there are hundreds of them, if not thousands, cropping up. It is obviously a pattern. Needless to say the company has an unsatisfactory rating with the Better Business Bureau.
Investors are left to ponder the risks:
What if an Attorney General opens an investigation?
What if the company's margins are dependent on a business trick that is going away?
What if consumers' behavior with regard to rebates changes?
and worst of all...
What if the rebate processing company used by TigerDirect also turns out to be owned by SYX ? In fact, OnDirect, the company that processes TigerDirect's rebates, is owned by Systemax! Ouch!
Kind of makes us wonder . if the customer has mailed in his proof-of-purchase, and the company denies the rebate and refuses to return the proof-of-purchase... ummm, what happens to that rebate?
This is not the first time the company has walked the line with consumers. They have a track record of prior litigation with the FTC over "advertising and warranty issues".
Stocklemon thinks it will take a subpoena to find out the answer to many of the questions regarding their current business of rebates. Cautious investing to all.
Disclosure: Author is short SYX