About a month ago, I revisited Gaiam (NASDAQ:GAIA) after reading a good article on the stock on SA and seeing the stock had declined 15% or so from when I'd looked at it a year earlier. Originally, I was a bit uncomfortable with my downside. I felt some of the valuation assumptions were kind of arbitrary and I just couldn't get comfortable. I began writing an article summarizing the bull case and then introducing some doubts to the thesis, after which I planned to conclude that the stock was not truly a conviction buy yet. I didn't finish writing the article because I was concerned I didn't have something worth publishing and was feeling diminishing return on time in the research effort. Since then I've passively given it more thought and the stock has declined another 22%. As a result, I'm now much more bullish. As such this will be a bullish article, but I am also including some of what I had a month ago to show the change in sentiment and an example of how irrational I am. It also offers a more balanced perspective and I think some of the old points are very valid.
Like most human beings, I tend to think in narratives. Once you learn the investing lingo like value trap, sum-of-the-parts, economies of scale, etc. and if you're reasonably intelligent as I sometimes think I am, you can make a decent argument for most any stock as a buy or sell. That frame/narrative/argument/whatever you want to call it doesn't mean it's actually a good or bad idea. It just means you're good at making yourself and others think it is. There's a big difference. So this article will lay out a bull case for Gaiam, but also serve as a little case study in the psychological flaws of an investor. Who knows - maybe I was right a month ago and wrong now…
A month ago when I was looking at Gaiam and trying to figure out how to value it, I wrote:
I've learned to become skeptical of SOTP stories and catalysts though. They are often too good to be true. The SOTP story at Gaiam has been well-documented for years. Investors have also been wrong about the catalysts before. I remember looking at Gaiam in late 2014 when they were just beginning to talk about the Gaiam TV spinoff. Investors assumed it would occur early in 2015 and serve as a catalyst. The company did file a Form 10 in early 2015 (February) to initiate the process, but several amended filings later and no guaranteed board approval yet, the catalyst has not yet played out.
For some reason, the SOTP approach also seems to encourage aggressive valuation level assumptions - maybe because comp analyses are often used and these tend to be aggressive. In this case, I think it's very dangerous to use Netflix as a comp because that assumes that Netflix is fairly valued. NFLX trades at 8x EV/S and almost $1k/subscriber. I've not done any research on it and don't feel fit saying whether it's valuation is fair or not, but I think the numbers mentioned above are at least enough to cast some doubt on it.
I'm not saying that there isn't value in GAIA, I'm just saying that the story is not as tight as it may initially seem.
I realize now that the reason I struggled with valuing Gaiam a month ago is that it can't be valued the way I normally do it. I normally like to load 10 years of financials into an excel template I have, run a macro to format it pretty, generate a bunch of averages, etc., and then plug numbers into a table I have that is driven by EBIT multiples. In hindsight, it should have been obvious to me that I couldn't take that approach with Gaiam. First, the 10-year financials are not nearly as meaningful as they normally would be because Gaiam has had a ton of investments and divestments even just over the last few years. One that comes to mind is Real Goods Solar, an asset entirely unrelated to Gaiam Brands and Gaiam TV, which is now gone. Gaiam TV has only been an initiative of the company over the past few years. The 10 year financials don't really reflect the past performance of the 2 current assets and they definitely don't reflect the prospective performance of either of these assets. Gaiam Brands is growing double digits and beginning to show its op margin potential given its historic >40% gross margins and increasing scale. Gaiam TV is growing >30% and management has said, straight out in recent calls, that they could make it grow 80% y/y if they wanted to - it's just a matter of subscriber acquisition spend and lifetime value.
No, these businesses need to be approached differently. I've decided to get away from the line items and just offer a little narrative explaining what I am valuing all the value components at and why:
There is still some arbitrariness in here and the risks of using SOTP still apply, but I'm more comfortable with it now because a conservative SOTP with Gaiam is a much better approach than pigeon-holing it into an inappropriate alternative model. 2-3x revenue for Gaiam TV is very arbitrary - I've always thought revenue multiples are. However, Netflix trades at 6 revenue and enterprise value of almost $40B, Gaiam TV is profitable, even with tremendous subscriber acquisition spend that is expensed, and 90% of its 7,000 titles are exclusive. This is a valuable asset and I do think Netflix, another media company, or someone interested in the demographic like Lululemon (NASDAQ:LULU) would be more than willing to pay 2-3x for the whole thing. This is not just me using Netflix as a comp and saying Gaiam TV could be worth that. If you think about what a strategic buyer would pay for all of Gaiam TV, I think 2-3 revenue is fairly conservative. 7,000 mostly exclusive titles for $55 seems like a reasonable price to a company like Netflix, which has blockbuster movies that have box-officed hundreds of millions of revenue (though Netflix has only paid a small fraction of that). In 2012 Netflix agreed to pay around $300mm per year to license Disney (NYSE:DIS) content. That Disney content is obviously far more valuable than what Gaiam TV has, but it's not an apples-to-apples comparison because that's a $300mm annual payment whereas $55mm for Gaiam TV would be a one-time payment for outright ownership. The other thing about the 2-3x revenue is that that's not reflecting full monetization. This service has only been out for a few years and it's doubtful that it's anywhere close to reaching its potential. Even 3 years from now that's likely to still be the case. 2x T+3 revenue could very easily work out to 1x T+6 revenue. There is a lot of danger to thinking too much about valuation this way because at the end of the day it's about the profit potential of Gaiam TV, not revenue, but on balance I do think 2-3x revenue is reasonable. It's not worth a tech-bubble valuation but it's not worth nothing either.
Gaiam Brands is an asset I'm really impressed with. This may be one of the 2-3 market leaders in consumer products focused on the yoga / spiritual demographic, next to Lululemon at least. Nike (NYSE:NKE) and Under Armour (NYSE:UA) probably have big market share, but they are not focused exclusively on this demographic and they are probably not perceived as being as genuine and true-to-roots as Gaiam is. Anyone interested in Gaiam must, must, must read up on the company's chairman, Jirka Rysavy. He's as genuine as it gets when it comes to reaching that demographic.
For a $120mm company, it's surprising to me that some people in my family who are by no means hardcore yogis own and embrace Gaiam DVDs, blocks, mats, etc. On Amazon, 3 of the company's products are in the Top 20 Best Sellers list for the Yoga Equipment category.
Gaiam Brands has a ton of doors in chains like Target (NYSE:TGT) and Kohls (NYSE:KSS). Growth and margin expansion are not pipe dreams. It grew revenue 24% last quarter and 16% YTD. In my analysis I'm only assuming 13% and 0% respectively. The overall company has had >40% gross margins for 10 years, and while I think the long-term numbers are generally not representative, I do think Brands has consistently done >40% gross margin. Typical SG&A for a consumer products company at scale is as much as 20-25%, so the Brands should be capable of 15-20% at scale or as a division of a bigger company like LULU. As a standalone now with all of Gaiam's heavy corporate overheard included, it is doing 5% margins, and that improved to 6.25% in Q3. I think 10% is very feasible in a few years even as a standalone, and could prove conservative if it's bought, which I think is possible. To a large consumer products company looking to penetrate the yoga/spiritual demographic, Gaiam Brands must look pretty attractive.
Previously I mentioned the pending spinoff of Gaiam TV, but I only dedicated one sentence to it. This is actually a big deal. The way I see it now, this is a catalyst regardless and a heads I win, tails I don't lose much situation regarding the various outcomes. Shareholders have been waiting patiently (perhaps impatiently based on the recent stock move?) for over a year for the spinoff. Apparently, the spinoff may not ultimately be approved by the Board. It seems like what the company is trying to do is sell Gaiam TV. It's worth much more to a 100% holder than in the public market as a standalone. With only $14mm of run-rate revenue right now, public company costs would be >10% of revenue and it wouldn't have the resources to grow at the rates it wants to. As a small piece of a big buyer, that story changes entirely. A sale would fetch a good price and the cash would be here and now rather than a few years from now. That's the optimal outcome, but it's probably not very likely at this point. The other outcomes are that Gaiam keeps it and cancels the spinoff, which is a good outcome and what I assume in my valuation. The worst outcome is them actually doing the spinoff, but while this would be structurally unattractive long-term for the reasons I mentioned above, it could trade at a frothy multiple in the public market as a standalone temporarily because of comps like Netflix in this market environment.
Risks and Framing
Readers should note that the way I'm framing Gaiam is as it is now and how I expect it to be in the next few years, that is, profitable, but this business has a history of large losses, changes in strategy, and wasteful capital allocation. For a long time the company seemed to have a demographic and vision, but not a monetizable business strategy, and certainly not one they stuck to. There's always the chance the strategy changes again, the operations are neglected and revert to losses, capital allocation does more damage, etc. It is certainly worth doing a survey of this company's history and taking that into consideration.
To some extent, the argument that Gaiam has been a value trap / dead money before is unfair because various factors have changed that make the stock more attractive here. For one, the company's businesses haven't both been growing at greater than 20% in the past:
The company hasn't always been so focused. The company had forays into solar, non-theatrical video production, real estate (the office building in Boulder), etc. With the spinoff and expected sale of the building, we get something that's been a long-time coming for Gaiam - two focused, pure-play businesses.
Whatever happens, it doesn't make sense for Gaiam to trade lower and lower as we get closer to closure regarding the spinoff and as business performance in both segments improves dramatically. I still have my doubts - what if they do something really stupid on the capital allocation front? It wouldn't be the first time. That combined with Gaiam TV actually being spun off and not perceived well by the market could still create a bad outcome, but I'm more comfortable now with my way of assessing reasonable outcomes here and I think they look pretty good in terms of expected returns and downside risk. With the recent decline, Gaiam is a at a multi-year low and I think now is a good opportunity to take a small position and begin following it more intensely.
Disclosure: I am/we are long GAIA.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.