In the last few weeks you were hard pressed to find any real major insider buys in any single company. But then all of a sudden we had an aggregate $8mil purchase from a CEO running a retail company with a current market cap of $100mil. That is 8% of shares outstanding folks - and I'm going to share with you why he did it. It's also why I've been watching shares closely and I immediately purchased shares once I read that CEO Dennis Pence made a $7mil open market purchase.
Coldwater Creek (CWTR) has the misfortune of being in a business that has to match merchandise with the changing tastes of women's fashion. It has been on the wrong side of that equation for the past few years. It has net losses on the books and is restructuring - focusing on the right things - closing underperforming stores, reducing expenses, but most importantly clearing inventory and concentrating on getting the right merchandise in front of consumers.
Investing in Coldwater Creek is investing in a distressed retailer. No easy task if you take a look at Gap (GPS) or Talbots (TLB). However ANN Inc and Chico's FAS (CHS) are two that have been relatively successful. Neither had a CEO who made as big of an open market purchase as Coldwater's though!
So what was CEO Pence seeing? He was seeing this (#s are annualized):
|Net Income (for '11)||(100,000,000)|
|Operating Cash Flow***||20,000,000|
|Free Cash Flow||15,000,000|
***Operating cash flows I've adjusted assuming a $60mil improvement in expenses and operating income performance over 2-3 years. Please feel free to take this with a grain (or 5 pounds) of salt. Distressed investing ain't easy.
In all fairness, capex is totaling a runrate of about $10mil this year. If you don't break out mainteance and growth capital expenditures like I do, then you'd assume it has about $10mil in free cash flow. Since it is distressed I'm assuming that 1/2 of the Capex will improve cash flow and 1/2 of it will be used to maintain current cash flow. As an FYI for operating cash flow I simply just added back Depreciation and Amortization. I'll provide 4 different valuations below:
Solid Capex Deployment Valuation - approx 100% return
With $15mil in free cash flow, Coldwater's return on invested capital (ROIC) is about 6%. If I apply that return to the growth capex, in 5 years I have potentially $20mil in capex. I take a 10x multiple on that and shares should be worth over $2/share.
Poor Capex Deployment Valuation - approx 50% return
If I assume that free cash flow is indeed really $10mil, the ROIC goes down to 4%. If I apply that growth rate of 4% on cash flows, it can potentially reach about $13mil in cash flows. With a 10x multiple that will equate to about $1.50/share.
Distressed Valuation - approx a negative 30% to positive 15% return
With a book value of $136mil, I think shares can be worth a 20% discount to that valuation (Inventory and Property are primary assets) that would equate to $110mil and a price of about $1.20/share. Another way to look at it is to say that with $10mil in current cash flows it is worth 10x or $100mil, which is prettty much the current market cap.
The company has to really screw up in other words to get down to a sub $1 valuation, which will mean eating up the cash on the books and taking on more debt to support the business. So if cash goes down to 0, Enterprise value will total $100mil (the current market cap). If I discount that by about 30% it'll be a valuation of about 75 cents or about 30% declne from current price.
The Home Run - 200-500% return
A successful turnaround will mean that income will at least become breakeven. All of that should flow down to cash flows. If I add back the losses of $40mil, cash flows can potentially hit $30mil to $50mil. At a 10x multiple that can equate to a share price of more than $4.
Simply put - this is a very very risky investment on my part. But it's worth the risks in my opinion. Please remember that this is a potentially 2-3 year investment as the company is only in the midst of turning around. To summarize some points:
- The asset base has been deteriorating and book value has/is going down
- I'm not 100% sure about my income expectations, which are my primary determinants of valuation
- It's currently at a distressed valuation
- I'm banking on CEO Pence turning it around
- I'm banking that he's motivated and will be at least partly successful given his $20mil investment in the company (20% of the company)
- I'm banking that his recent purchase is a buy signal and that things are improving faster than the market is expecting
- My valuations, and even the distressed valuation scenario, are generally on the optimistic side
This one will be fun to watch at the least.
Disclosure: I am long CWTR.