Cybex's Fate In The Balance: The Asymmetry Of Crisis Investing

| About: Cybex International, (CYBI)

Cybex (NASDAQ:CYBI) is a 40 year old fitness equipment maker whose logo may be found at your local gym. It traded above $7 before the recession. Just as the recession was ending, however, it was hit with a negative decision in a product liability lawsuit, and an unprecedented jury award that has rendered CYBI a penny stock.

So Cybex, a household name, whose sales just climbed 15% to an annualized $130M, and which has otherwise returned to profitability, is threatened with delisting by the NASDAQ as soon as this December.

Central to Cybex’s situation is a tragic accident in 2004, in which a 20 year old Cybex leg press fell over on Natalie Barnhard, an employee at Amherst Orthopedic Physical Therapy in Buffalo, NY. Ms. Barnhard was rendered a C5 paraplegic, meaning that she lost hand and wrist function, and is confined to a wheelchair for life. She is a young woman. Her suffering and grief at her diminished prospects in life are beyond imagination. Cybex and Amherst have repeatedly expressed sympathy.

Had Ms. Barnhard been a member of the facility, she would have signed the facility’s waiver; but as an employee, she had not signed a waiver.

Despite the lack of any defect in the machine, a jury found Cybex 75% liable for the $66M award (Cybex’s insurance covers only $5M per incident). If upheld on appeal, Cybex faces bankruptcy, with its 600 employees out of work.

If overturned, however, CYBI may 5-bag, or even 10-bag; it would triple by just returning to book value. This asymmetry is familiar to gamblers, but not to most investors. The astute action may be to buy even if you think the chance of an overturn is unlikely (but above, say, 20%).

Adding to the drama is Cybex’s CEO, John Aglialoro -- who ironically is also the producer of the film version of Atlas Shrugged, which decries the exploitation of innovators by lawyers. Mr. Aglialoro is a blue blood industrialist, who denies any liability by Cybex and is appealing all the way.

So whether Cybex survives is now in the hands of the NY State Supreme Court’s Appellate Division, where last week a 5-judge panel heard Cybex and Amherst’s appeals. Their decision is imminent, to be posted to the court’s website as soon as November 10.

Cybex and Amherst appear to have reasonable grounds for an overturn, given the lack of any actual defect or negligence, the unprecedented award amount, and numerous irregularities at the original trial. Cybex president Art Hicks is confident of a reversal on appeal.

Your assessment of their odds depends on how you view the arguments brought up at appeal:

  • Everyone agrees that Ms. Barnhard was misusing the machine. She claims she was stretching against the back side of it (causing the 500 lb machine to fall backwards onto her when she pulled on it). Cybex’s attorney suggested that she was climbing on it.
  • The only witness to Ms. Barnhard’s use of the machine (just before the accident, but not the accident itself) was prevented from testifying at trial. Cybex’s attorney claims that the witness was prepared to testify that she was climbing on the machine.
  • Cybex’s product manual recommends (but does not require) that the equipment be bolted down to the floor. Amherst had not bolted it down, and Ms. Barnhard knew it was not bolted down. Basically, no one bolts these types of machines down. (Given the age of the equipment, there was confusion as to whether the manual was the original version.)
  • It would have taken 40 lbs of horizontal force to tip the machine over, seemingly more than a petite woman would exert by simply stretching.
  • According to the Cybex and Amherst attorneys, the portion of the jury award for Ms. Barnhard’s medical care is 2.5 times the actual cost; and the non-economic (pain and suffering) damages of $33M are 3-5 times the maximum precedent. Some of the amounts in precedent cases had been established by the appeals court judges themselves.
  • The jury award included all sorts of irregular items, such as cost of care for a potential future child.

For his part, Ms. Barnhard’s attorney argued that:

  • Cybex’s liability is based on the leg press’ instability (on the back side).
  • A manufacturer has a duty to protect against foreseeable misuse.
  • There had been some design choices (e.g. direction of feet) that had favored convenience and footprint of the machine, and stability on the front (user) side, over stability on the back side.
  • Notably, he did not argue that the award amounts exceeded precedent.

Even with no overturn by the appeals court, it would seem that some sort of settlement is likely, because it is not in Ms. Barnhard’s interests for Cybex to go bankrupt.

The pace of modern medicine may offer a cure to those in Ms. Barnhard’s condition, in time for her to regain a healthy active life. Juries cannot consider such potential scientific advances, and so must assume a lifetime of disability. My hope is that the appeals court saves Cybex and Amherst, allowing for a settlement that provides for Ms. Barnhard’s needs, within the limits of their insurance coverage.

Note: I attended the Barnhard vs. Cybex appeal in Rochester, NY on 10/26/2011. It did not appear that any reporters were present. There has been very little recent coverage on this fairly momentous case.

Disclosure: I am long CYBI.