It’s been a while since I posted my first analysis on Gymboree (GYMB). I’m still long and the company has continued to perform well. The stock had a nice run, but has come back down near the levels where I originally posted my analysis. The purpose of this update is to refresh my financial analysis and, given the recent decline in the shares, evaluate if we are back near a buying opportunity. I won't repeat my entire long thesis, so please refer to the earlier post linked above if you aren't familiar with the company.
Net asset value
Based on the balance sheet analysis shown below, I peg the reproduction value of Gymboree’s assets at approximately $25 per share as of its 5/1/10 financial update. The most material change from my prior analysis is really just that cash has increased by about $2 per share, supporting the rise in NAV from $23 to $25. (Click to enlarge)
Earnings power value
Again, no huge change here – the major variance is still the continued buildup of excess cash on the balance sheet (+$2/share) while the increase in earnings and slight reduction in share count contributed modestly (+$1/share).
I’m keeping my assumption of a 6% rate of growth constant. As noted in my previous post, Gymboree has grown its revenue base at a compound annual rate of approximately 8% over the past decade. Revenue held steady during the severe consumer economic decline in 2009, and was up 10% year-over-year for the most recent quarter (+2% same store sales). The company continued to open new Crazy 8 stores at a fast pace, and its very high return on invested capital continues to create substantial additional shareholder value through growth. Using 6% as a conservative estimate of long-term growth, I arrive at a GV of $69 per share. Note again that over $2 per share of this increase in GV from $64 to $69 is again due to the cash increase. I would probably classify the remaining $3 of increase as noise in the valuation, which isn’t material given that we’re talking about an amount of less than 5% of our estimated GV… these calculations just aren’t that accurate.
As an aside: if you compare the two growth value calculations, you’ll see that this EV increase of 4% (excluding the impact of the cash increase) came about as EBIT increased by a little over 1% and the growth rate was held constant. The variance is a result of small changes in the invested capital, which I would argue just aren’t that statistically significant on a real-time basis for small movements.
Valuation continuum and margin of safety assessment
The chart below summarizes the updated valuation work compared to the current trading price.
I’m adding this as a little thought piece… I have no information regarding a pending transaction, but obviously the credit markets have returned (though conditions vary week by week) and leveraged buyouts are happening again. There is still a lot of money out there chasing deals and, while GYMB is definitely not trading as an LBO candidate, I think there are several points that bear mentioning:
- There is a lot of dry powder remaining in large LBO-land and (as credit markets allow, natch) deals in the $1-2 billion enterprise value range are right in the strike zone of a lot of funds. There are plenty of people out there that could stroke the $500-$600 million dollar equity check to do this deal.
- As evidenced by the list below, LBO firms know retail. They’ve done it before and will do it again.
- Companies were put through a pretty good stress test during the financial crisis and recession. Based on its steady performance, I would say that GYMB outperformed a majority of companies in the LBO shops' portfolios. Given that the larger firms are focused on lower-beta, return of capital type deals (since their management fee alone, before carry, creates enormous wealth), safer plays like GYMB should be attractive. As I noted in my initial post on GYMB, the demographics are favorable, they have the different price point strategies to adapt to economic conditions, and their products suffer from far less fashion/fad risk than other apparel categories.
Where does all this lead? Courtesy of the sweat, blood and ruined weekends of the analysts at Goldman and PJSC, I lifted the following table of transaction comps from the Claire’s Stores (CLE) fairness opinion. There are some relevant missing deals, these are relics of a different time, and obviously some of these ended poorly (and have long since been liquidated). However, there are some winners on this list.
Do I believe there are people lining up today to pay 8-9x EBITDA for mediocre retailers (Linens ‘n Things) and over 10x for retailers with obvious cyclical exposure? No. However, it also isn’t crazy to believe that you could see bids in the 6-8x EBITDA range for a company that sailed through the downdraft with stable/growing sales and earnings, that is currently demonstrating organic growth in the high single digits. Where would that type of a transaction value GYMB?
It's hard to envision a board of directors taking less than $60 per share, given that the stock recently traded in the mid-50's, and even $60 is only a 7.2x multiple of LTM EBITDA. Quite likely, a good banker would get the price 10%-15% above the $60 level.
Summary and conclusions
Based on the current trading level of $44-45, Gymboree is trading near where I calculate the margin-of-safety buy point (35% discount to the GV of $69). My previous buy point was $42, and the company has added over $2 per share in cash since that analysis. At the current market valuation, you are barely paying over EPV and getting any growth of the company for free. If growth is disappointing due to renewed economic weakness or other factors, the EPV should provide a reasonable support for the company (which currently trades at ~10x EPS, adjusting for cash). In addition, I believe a private equity buyer would value the shares at $60 or above, and GYMB could be an attractive target if credit market conditions allow. An exit at 60 would be a gain of over 33% from current levels.
Disclosure: Author and/or family members are long GYMB stock