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In response to my recent article, The Impending Implosion of StoneMor Partners, the company issued a press release that fails to refute my key arguments and further misleads investors. StoneMor’s frantic attempts to deceive investors into ignoring the obvious – its terrible business model and financial situation – reminds me of the scene in The Wizard of Oz when the wizard tells Dorothy to “pay no attention to that man behind the curtain.” StoneMor’s financial statements don’t mislead – they tell a clear (and damning) story – but the company’s management sure does…

False Comparison to Other MLPs

In the third paragraph of its press release, StoneMor writes: “Because MLPs pay out most of their cash flow to unit holders, StoneMor, like every other MLP, finances these acquisitions with debt and periodic equity offerings.” This is cleverly worded to be a true statement, but is highly misleading. Most MLPs pay out genuine profits/free cash flow as dividends, and then raise capital to fund expansion. However, in StoneMor’s case, as I wrote in my last article, the company over the last 13 quarters:

“has averaged a mere $1.4 million in free cash flow per quarter, yet has paid a dividend averaging $8.9 million per quarter (and nearly $12 million in each of the last four quarters), resulting in a cash burn that has averaged $7.5 million per quarter. This is clearly absurd and unsustainable.”

To see what a normal MLP looks like, consider one of the largest, Kinder Morgan Energy Partners L.P. (NYSE:KMP), which has a $27.7 billion market cap and pays a 6.2% dividend. Over the last three years, cash flow from operations has been robust and growing, from $2.1 billion in 2009, to $2.4 billion in 2010, to $2.9 billion in 2011. Meanwhile, dividends paid to shareholders (or, to use MLP terminology, “distributions paid to unit holders”), were only $0.8 billion, $0.9 billion, and $1.0 billion. (A few comments on my previous article argued that my use of the word “dividends” instead of “distributions” signals a misunderstanding of MLPs, which is nonsense since they’re the same thing as StoneMor itself acknowledges: it has a “Dividends History” section on its website.)

To compare STON and KMP, let’s adjust the latter’s cash flow and dividend payments to reflect the fact that STON only has 1.7% of the market cap of KMP. On an equivalent market cap basis, KMP’s cash flow from operations would be $49 million and the dividend payment would be $17.5 million. In sharp contrast, in 2011, StoneMor generated a mere $5.5 million in cash flow from operations, yet paid out $44.6 million in dividends.

Misleading Table

In the next part of StoneMor’s press release, it presents a table showing “the sources of debt and equity capital obtained since 2007 and the use of this acquired capital.” Again, the table is technically correct, but highly misleading. Shockingly, under “Capital Sources”, the company doesn’t even present what for most companies is the primary source of capital: profits or cash flow! Similarly, under “Capital Uses”, StoneMor neglects to include the dividend payments, which are, by far, the company’s largest use of capital.

Apparently, what the company is trying to show is that the capital it has raised has gone toward “legitimate” uses like acquisitions, working capital, and debt repayments, rather than the “illegitimate” use of funding its dividend. The only way the company is able to show this point is by highlighting how much cash is consumed by the growth in accounts receivable and in the merchandise trust, which totaled $31.1 million in 2011 and $92.7 million in the five years shown in the table, 2007-11. It is somewhat puzzling for the company to highlight a major weakness in its business model: not only does it not generate much in the way of net income, but cash flows are even weaker than net income due to growing working capital needs.

Assets, Equity and Debt

The company then trumpets, “By following this formula, the company has effectively increased the size of its asset base while not significantly increasing its debt load which has allowed it to remain flexible and opportunistic in the acquisition market. As the table below exhibits, we have grown the company significantly without increasing the total debt.” The company then includes a link to the following chart:

click to enlarge

Once again, true, but misleading. StoneMor would like to have you believe that it’s been able to grow assets without growing debt very much the way a normal, healthy company would, by reinvesting the profits of the business, but StoneMor has no profits to speak of – instead, it’s grown its assets by issuing stock, thereby diluting shareholders. This chart shows how the share count has doubled in the past three years:

In addition, the key metric for investors isn’t total assets, but tangible equity (book value or partner’ capital, minus goodwill). This chart shows this metric as well as net debt since Q1 ‘09 (note also that while tangible equity has risen slightly, the share count has doubled during this period, so tangible equity per share has fallen by nearly 50%):

Now the story becomes clear: because StoneMor is paying out far more in dividends than it generates in profits or free cash flows, debt is rising and equity is falling steadily, offset only by big equity issuances in Q3 ‘10 and Q1 ‘11.

Liquidity

The press release continues with this head-slapper: “By continuing to grow, the company has built up a net asset base that will continue to provide for liquidity well into the future.”

This is utterly nonsensical. While it is true that StoneMor has grown and has built up its net asset base, how do hard assets provide for liquidity? In fact, precisely the opposite is true: by investing the cash raised from numerous debt and equity offerings in highly illiquid assets like cemeteries, StoneMor has dramatically reduced its liquidity.

Incorrect Presentation of the Balance Sheet and Liquidity StoneMor’s press release then proceeds to show this table:

March 31, 2012

(in thousands)

Cash and Accounts Receivable, net

$126,782

Merchandise Trust

355,027

Total Cash and Investments to Satisfy Liabilities

481,809

Accounts Payable and Accrued Liabilities

22,332

Cemetery Merchandise Liability

128,220

Payables and Merchandise liabilities

150,552

Net cash after satisfaction of liabilities

$331,257

Debt outstanding

203,126

Net cash after satisfaction of debt

$128,131

Following the table is this statement:

“Were StoneMor to satisfy all of its liabilities as of March 31, 2012, the company would still have more than $128 million in cash, 12,800 acres in cemetery land, perpetual care trusts with a value in excess of $250 million and 272 cemeteries and 76 funeral homes.”

This table and statement are completely misleading because they ignore the single biggest item on StoneMor’s balance sheet, Deferred Cemetery Revenues, net”, which was $438,349 as of March 31, 2012. Here is the explanation in StoneMor’s 2011 10-K (page 94): “Revenues from the sale of services and merchandise, as well as any investment income from the merchandise trust is deferred until such time that the services are performed or the merchandise is delivered.”

In other words, StoneMor has received cash from its customers for services and merchandise that it hasn’t yet delivered. Thus, accounting rules prevent StoneMor from recognizing this cash as revenue (and booking whatever profit might be associated with it) until the service or product is actually delivered.

This is quite common among many types of businesses – think magazine or newspaper subscriptions. Or consider Costco (NASDAQ:COST), which collects an annual membership fee from its shoppers when they first sign up, but can only recognize 1/12 of this fee every month so the unrecognized balance appears as a liability on its balance sheet called “Deferred membership fees”.

The key question whenever this situation arises is: What does the company do with the money, which it is effectively holding in escrow on behalf of its customers? The right thing to do, of course, is to hold the customers’ cash as cash, which is exactly what Costco does: it holds $6.0 billion of cash and short-term investments, far more than its $1.1 billion in “Deferred membership fees”.

So how much cash does StoneMor hold to offset $438 million of Deferred Cemetery Revenues? Less than $9 million!

It’s not as bad as it first appears, however, because rather than holding its customers’ money in cash, StoneMor is instead putting it into Merchandise Trusts, but this doesn’t mean that one can simply ignore the $438 million in Deferred Cemetery Revenues. A fair and correct analysis would add this liability to StoneMor’s table, offset in part by “Deferred selling and obtaining costs”. Adding these line items to the misleading table StoneMor presented results in a more realistic picture:

March 31, 2012

(in thousands)

Cash and Accounts Receivable, net

$126,782

Merchandise Trust

355,027

Total Cash and Investments to Satisfy Liabilities

481,809

[plus] Deferred selling and obtaining costs

70,730

[minus] Accounts Payable and Accrued Liabilities

22,332

[minus] Cemetery Merchandise Liability

128,220

[minus] Deferred Cemetery Revenues, net

458,349

Payables and Merchandise liabilities

538,171

Net cash after satisfaction of liabilities

($56,362)

[minus] Debt outstanding

203,126

Net cash after satisfaction of debt

($259,488)

Thus, if StoneMor were being honest, its statement after this table would read:

“Were StoneMor to satisfy all of its liabilities as of March 31, 2012, the company would have a deficit of more than $259 million in cash, a hole we would frantically try to fill by engaging in fire sales of 12,800 acres in cemetery land, perpetual care trusts with a stated value in excess of $250 million (but with liabilities exactly offsetting this), and 272 cemeteries and 76 funeral homes.”

Good luck with that fire sale!

GAAP vs. Production Based Revenue The final data that StoneMor provides in its press release is the chart below, accompanied by this statement:

“The company provides information on a production basis in order to allow the investor to understand the current sales activity and operating performance of the company. The following table illustrates the effect that growth has had on the recognition of revenues. In 2005, shortly after the company first went public and prior to the time that it began to experience growth, there was virtually no difference between GAAP and production based revenues.”

StoneMor is simply making the point that it has deferred revenues. So what? Costco could show a similar chart. All other things being equal, having customers pay up front is a good thing – but only if it’s a solid, nicely profitable business, which StoneMor most certainly isn’t.

Conclusion

The final paragraph of StoneMor’s press release is classic sophistry:

“Our business model provides a high level of predictability and stability. We have grown profitably even in challenging environments. The demographics of our industry provide us with a great deal of visibility into our future. There are very high barriers to entry to our business and the fragmented nature of the industry is also favorable to our model. We believe that we are ideally positioned to carry on our growth strategy and bring value to our unitholders. As previously announced, we will be paying our 32nd consecutive distribution, in the amount of 58.5 cents per unit, to unitholders on August 15th and will announce our second quarter earnings on August 7th, 2012,” concluded Miller.

Let’s go through this nonsense line by line:

First, the company writes: “Our business model provides a high level of predictability and stability.” In truth, it’s a terrible and unsustainable business model, only kept afloat by endless equity issuances and severe dilution of shareholders.

The company writes: “We have grown profitability even in challenging environments.” In truth, the company over the last 13 quarters has lost money more than half of the time – an average of $785,000 per quarter, as shown by this chart of StoneMor’s net income:

The company writes: “The demographics of our industry provide us with a great deal of visibility into our future.” This is the old “people are always going to die” argument. Well, duh, but this doesn’t mean that StoneMor is going to start earning profits, or generating sufficient free cash flow to cover its absurdly high dividend. Odds of that are, in my opinion, zero, which means this stock is hanging on a very slender thread: the ability of StoneMor to keep issuing more and more equity.

The company writes: “There are very high barriers to entry to our business…” In truth, this is a pure commodity business and this management team has proven it twice, first by taking The Loewen Group into bankruptcy, and now with StoneMor.

The company writes: “…the fragmented nature of the industry is also favorable to our model.” Yes, there are lots of small cemeteries and funeral homes to acquire, and StoneMor has been doing a lot of this, but has no meaningful profits or cash flow to show for it.

The company writes: “We believe that we are ideally positioned to carry on our growth strategy and bring value to our unitholders.” In truth, StoneMor’s terrible business model, rising debt load, increasing reliance on highly dilutive equity offerings, and disingenuous management have put the company on the brink of a meltdown.

Disclosure: Long STON Puts.

Source: StoneMor's Misleading Press Release: The Short Case Continued