Mothers Work: Empire Waists and Imploding Hedge Fund Stakes

I had a Peter Lynch moment a few weeks ago at the mall. My wife and I noticed that many of the women at the mall were wearing maternity style shirts. My wife pointed out a few tops that looked just like a maternity shirt she owned when she was pregnant with my daughter. However, these women did not appear to be pregnant. My wife even joked that she is now afraid to offer up her seat on the subway to women who appear to be in the early stages of pregnancy, because they might not actually be pregnant. They might instead just be wearing the latest styles.

This strange trend got me thinking. What would the impact of this latest style trend be on actual maternity clothing retailers and manufacturers? I quickly thought of Mothers Work (MWRK). I discovered that Mothers Work produces many of the major brands of maternity clothes during my wife’s first pregnancy. These leading brands include:

While still at the mall, I guessed that Mothers Work was probably facing declining sales and sagging stock price. A quick look at a stock quote for Mothers Work confirmed my hypothesis. The only question that remained in my mind was how long would this maternity like mainstream style continue.

I asked my wife about it and she pointed me to a Washington Post article that she had just read. The article directly addressed my question on what the author called the current “Empire-waist” look.

Q How long do you think the Empire waisted look will last? It seems that it only looks good on a size 0 or a pregnant woman (and I am neither!).

A The Empire-waist look has long had currency with fashion’s cognoscenti; personally, I love it, and I’m neither pregnant nor a size 0. But if it isn’t for you, fear not. The trend pendulum is already swinging in the other direction, and wasp-waisted styles will be everywhere come fall…

– Suzanne D’Amato
Source: The Look, Washington Post

According to this Washington Post fashion expert, this maternity looking style should be fading soon. That sounded like great news for my theory that Mothers Work sales, profit growth, and then stock price would recover nicely over the next year.

As a value investor, my next move involved estimating the value of Mothers Work. I first ran the Fat Pitch Finder Spreadsheet and found that based on free cash flow growth over the past ten years, it appears that the intrinsic value per share for Mothers Work is about $40 per share. At the time, MWRK was trading for about $25 per share. That potential margin of safety caught my interest.

I also just discovered a new spreadsheet at the SMF Add-In Group simply called the Cash Flow Model by Turley Muller. This spreadsheet is a bit overwhelming, but it is highly configurable and provides a pretty good way to explore a company’s fundamentals. Even after playing around with this spreadsheet for a few hours, I still came up with an intrinsic value estimate of about $40 per share.

Even though some of the fundamentals were weak and debt is rather high, I decided to go with my thesis. I added a full position in Mothers Work in the Fat Pitch Financials Portfolio on July 26, 2007 at an average price of $24.31. As is often typical with value investing, the price of MWRK plunged shortly after I made my purchase. A waited a bit and then decided to pick up another half of a position in Mothers Work for $18.82 on August 6th.

The stock continued to decline. At first I wasn’t concerned but I must admit when shares of Mothers Work dropped below $15 last Friday, August 9th, I started to panic a bit. I started to wonder if others knew something I didn’t about Mothers Work. The only news was that the company’s Chief Merchandising Officer had quit and sales were as poor as predicted for July, but that really shouldn’t have accounted for such a price decline.

Well, Mr. Market was up to his old tricks. I just discovered that troubled Bear Stearns (BSC) was a major holder of Mothers Work and probably was forced to sell a 6.2 percent stake in Mothers Work to raise cash to deal with their busted hedge funds. Now that bit of activity would account for the double digit percent decline.

I wish I had thought of this situation when Mother Works stock price dropped. I must admit I was watching the MWRK ticker last Friday when the stock dropped below $14.50 briefly. I almost pulled the trigger to buy more but I chickened out because I didn’t know why the stock price was going down. If I had looked at the major institutional holders, I would have noticed that Bear Stearns was on the list and I might have made the connection.

The lesson here is that it pays to look up which imploding hedge funds might own large stakes in your favorite stocks. You might just get a bargain in a fire sale.

Disclosure: I or my family own shares in Mothers Work. I made add to this position again within the next week. Neither I nor my family own shares in Bear Stearns.

MWRK 1-year chart