Brian Bolan, research analyst at Jackson Securities, sent a note to clients downgrading Blue Nile (NILE) based on its valuation. Key excerpts follow:
Blue Nile is a leading online retailer of high quality diamonds and fine jewelry. While not providing the lowest cost diamonds, the company believes its formula of no pressure sales, high quality educational material and reasonable prices will result in higher profits. Valuation and Recommendation
Blue Nile recently beat the street and saw a large shareholder increase its stake just prior to earnings. This caused the stock to vault higher to a level that triggered insider sales and reduced the likelihood of an acquisition of the company. We have revised our estimates and have adjusted our target price to $46 per share, but that is still $7 below current levels. We are changing our rating to sell based on this valuation gap.
Downgrade to Sell from Hold
We are downgrading our rating on shares of Blue Nile from hold to sell after the significant gap the stock has seen following its most recent earnings release. We believe this gap up in the stock benefited from a recent increase in ownership as revealed through SEC documents, as there were likely less shares available to be shorted.
The increased share price has caused insiders to sell shares, dampened the potential of an increased share buy back program and reduced the likelihood of an acquisition of the company.
American Capital Group increases stake.
Following the most recent earnings release, it was revealed through a SEC form that American Capital Group increased its stake in the company to 12.6% of the shares outstanding. This increase is significant and likely to be a contributing factor for the gap up in the stock price following the earnings release. The form notes that the stock was purchased prior to earnings, but likely took away the potential for those shares to be shorted.
Since May 1, insiders led by Chairman and Chief Executive Officer Mark Vadon and President, Chief Financial Officer and Director Diane Irvine have sold more than $16M worth of Blue Nile Stock. Vadon sold 250K shares for $13.7M at an average price of $54.98 from May 10 to May 14 according to a SEC filing. Irivine sold 40K shares on May 10 and on May 11 exercised 25K options and then sold those shares. In total, the shares sold for about $3.6M with an average price of about $54.75 each.
It is normal practice for insiders to sell shares during certain windows, as this particular sale was, it still shows a lack of faith in the investment potential of remaining shares they own. We note that both parties still hold a significant number of shares.
Shares outstanding and the buy back
During the previous quarter, Blue Nile repurchased 344,655 shares of its common stock for about $13.5M. This works out to an average price of $39.16. There is approximately $79.7M left on a buyback that expires in August of 2008.
Due to the increase in price, we do not believe the company’s buyback program will be able to support the stock in the near term.
Guidance and our Model
In the earnings release, Blue Nile guided Wall Street to topline of between $65.5M - $67.5M and a bottom line number between $0.16 - $0.17 per share for the second quarter of 2007.
For the fiscal year 2007, the company guided to $295M - $305M on the topline and between $0.86 - $0.91 per share on the bottom line. The expected tax rate for 2007 is 35.2%.
Our model is calling for $67.9M on the topline and $0.17 per share in earnings for the second quarter of 2007. A very modest 18.7% gross margin is also assumed by our model which might even be too low.
Our model for the company can be found at the end of this report.
Take our premium should dry up
Following the earnings release, shares of Blue Nile gapped higher by about 8 points. We believe this is due in part to the acquisition of shares by American Capital Group and the better than expected results. We note that there was a sizeable gap between our estimate and the interest income as well as the $200K from a legal settlement, both of which aided the bottom line. Combined, these items will likely reduce the chances that another company would look to acquire Blue Nile.Quantifying the take out premium is a difficult task to accomplish. We believe that investors will continue to realize that a purchase of Blue Nile will not result in significant synergies for a number of potential acquirers.
We also note that a major competitor, Amazon.com, who saw its stock rise dramatically following its 1Q07 earnings release, has seen its jewelry business continue to grow by more than 100% on a year over year basis. Even with a newly boosted source of capital in its higher stock price, we do not believe that Amazon would be willing to pay a price dramatically higher than where Blue Nile currently sits.