Crown Crafts, Inc. (NASDAQ: CRWS) sells a range of infant and toddler products including bedding, bibs, disposables, and accessories. The company sells these products directly to retailers, including Wal-Mart (NYSE:WMT), Target (NYSE:TGT) and Toys R Us, as well as mid-tier and specialty stores. Last year was rough on CRWS, with shares sinking 36% despite growing revenues, and a major (~$6.5 million) reduction in debt. At the time of writing (1/4) the company is trading for a market cap of about $34 million and with an additional $1 million in net debt. Compare this to the company’s TTM free cash flow of $7.7 million, or four-year (post Churchill subsidiary liquidation) average free cash flow of $5.6 million, which represent strong 22% and 16% yields respectively.
Over the last decade, essentially all of the company’s free cash flow has been used to repay debt, and the company recently began paying a dividend (current yield is a strong 4.6%). The following chart shows the company’s efforts to recapitalize itself:
Crown Crafts, Inc - Capital Structure, 2000 - 2Q 2012
Additionally, in 2011 the company engaged in a minor proxy skirmish with Wynnefield Partners Small Cap Value, L.P., which is the company’s largest shareholder (~17%). The battle ended in an agreement between the parties whereby Wynnefield’s representative, Patricia Stensrud, was nominated as a Class III director. This nomination was merely to replace one of Wynnefield’s previous representatives (emphasis added), and not to push for any specific reform.
Under the terms of the Standstill Agreement, one of the nominees of the Wynnefield Group, Mr. Joseph Kling, was immediately elected to the Board, and the Company agreed to include Mr. Kling in its slate of nominees for election as a Class III director of the Board at the Company’s 2008 annual meeting of stockholders. Mr. Kling’s term as a Class III director expires at the 2011 Annual Meeting. …
On May 20, 2011, the Wynnefield Group sent a letter to the Board’s Nominating and Corporate Governance Committee suggesting that Ms. Stensrud be considered as a Company nominee for election to the Board at the 2011 Annual Meeting. Unfortunately, the Company did not respond to the Wynnefield Group’s suggestion that Ms. Stensrud be considered for nomination by the Company for election to its Board prior to the deadline for stockholders to timely submit nominations pursuant to the Company’s nomination notice procedures set forth in its Bylaws. Absent any response from the Company and in order to preserve the right of the Wynnefield Group to nominate Ms. Stensrud as a member of the Board, on May 27, 2011, the Wynnefield Group delivered a letter to the Company notifying it that the Wynnefield Group intends to nominate and seek to elect Ms. Stensrud as a member of the Company’s Board at the 2011 Annual Meeting. Ms. Stensrud has advised the Wynnefield Group that the Board’s Nominating and Corporate Governance Committee has never contacted her to discuss her qualifications or business background.
After this agreement was made and the proxy skirmish settled, Wynnefield did provide some useful information about problems at the company and desired reforms (emphasis added):
The shareholders of the Company have repeatedly indicated they want more outside voices on the Board and the key committees of the Board…
First, as we have repeatedly communicated in the past, one of the most important responsibilities of a board of directors is to provide for succession planning with respect to a company’s CEO. It is an abdication of the Board’s duty to manage risk for it not to have implemented an effective succession plan. …
We believe that, by creating a vacuum with respect to possible successors to Mr. Chestnut as CEO on the Company’s management team, the Board essentially prevents shareholders from challenging the actions of the CEO under threat of either the desire to preserve the status quo or threat of triggering the inappropriate Golden Parachute/Poison Pill leaving the Company leaderless. By not employing a senior industry-experienced executive to serve as either an Executive Vice President or Chief Operating Officer, Mr. Chestnut is able to hold all the cards in his hand and close to his chest, perpetuating his absolute control over the company’s operations, relations with its suppliers, and vendors. …
Second, we have also repeatedly challenged the existence of a staggered Board. …
The third critical governance issue relates to the size of the potential change of control payments payable to the Company’s senior executives. In our view, this agreement is outsized, excessive and completely inappropriate. To put these golden parachutes in context, upon a change-in-control, the combined severance payments to senior executives would exceed the Company’s entire net income for FY2011. …
We are also extremely dissatisfied with the Company’s lagging financial performance. This is reflected in its stagnant long term share price and substantial trading discount to its peers. …
The strategy of engaging in small tuck-in acquisitions merely masks the Company’s declining core infant and juvenile bedding business. Reducing investment in product development as evidenced by the failure of the company to internally develop successful new products, coupled with failure to make any meaningful improvement in the Company’s market penetration for its existing core products, are also recipes for maintaining the status quo. …
As a shareholder for over 15 years, we have repeatedly stated that we are committed to work constructively with the Board to promptly address the critical issues and are willing take whatever steps necessary to create value for all stockholders.
Wynnefield is a long term holder and will continue its efforts until Crown Crafts is governed and operates in a manner consistent with the creation of shareholder value.
So the situation we are dealing with appears to be a highly entrenched CEO and board, which own very little of the company. The company’s largest shareholder (and a longstanding shareholder too!) is upset, and the market appears to agree that something is wrong with the company.
This alone would be sufficient to make me pass on the company, despite its strong free cash flows and significantly strengthened balance sheet. Unfortunately, there are more risks to note.
One risk is that the company has highly concentrated revenues, with approximately 40% of revenues coming from Wal-Mart, and about 1/5 from Toys R Us. Target usually accounts for around 10% too, meaning that the top three customers usually account for 70% of sales. This leads to less bargaining power and sets the company up for a higher likelihood of revenue disruption. The loss of WMT or Toys R Us could spell disaster.
Another risk is that the company is reliant on licenses that expire soon. 50% of the company’s sales are from products that include designs that incorporated trademarks that the company licenses from third parties. 38% of revenues are from licensing agreements with The Walt Disney Company (NYSE: DIS), and many of these license agreements expire over the next 24 months:
Crown Crafts, Inc - License Agreements and Expirations, from Fiscal 2011 10-K
Though the company has these licensing agreements, the filings do not suggest that these are exclusive, so I do not believe this is a source of a sustainable competitive advantage. At the time of writing, the company had not publicly discussed whether its Toddler Bedding license agreement that expired on December 31 had been renewed.
The company is also highly exposed to expenses outside its control, due to the nature of its products, which rely on cotton and petroleum inputs. The spike in cotton prices last spring was significant for many retailers, but I would hesitate to suggest that this is anything other than a temporary issue without long-term consequences to the company’s valuation. Your thoughts on the price of oil may lead to different conclusions about the company’s gross margin in the future.
The company has also experience shareholder dilution with shares outstanding growing by 446,000 shares (4.8%) over the last three years despite $1.8 million in net repurchases over the period. Rather than reducing the share count, these repurchases had the effect of transferring money to insiders.
Given the risks, I think the low multiple to free cash flow is justified, though if Wynnefield is successful in its efforts to reform the company’s corporate governance, we could see an opportunity emerge in the future.
What do you think about CRWS?