Aaron's Inc. As An Opportunistic Investment

| About: Aaron's Inc. (AAN)
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The company has attractive fundamentals. It is profitable, generates significant free cash flow and has a solid balance sheet.

The company is, by some metrics, undervalued.

The company is in play and has an offer from Vintage Capital.

Aaron's, Inc. (AAN) is engaged in the lease ownership, lease and retail sale of products such as wide-screen and LCD televisions, computers, living room, dining room and bedroom furniture, washers, dryers and refrigerators.

The private equity firm Vintage Capital Management has made several offers over the years to buy Aaron's. The most recent offer was in February, when Vintage made a $2.3 billion bid equivalent of $30.50 per share. Aaron's responded by forming a special committee to review potential options. Vintage is also challenging the independent directors to either bring in a new management team or sell the company. Vintage owns 7,277,000 shares (10.1% of the voting total).

Aaron's net income fell 30 percent last year, in part due to weak demand from low to middle-income customers who still face economic pressures. Revenue climbed 1 percent, the slowest pace since at least 1996, data compiled by Bloomberg show.

The short-term risks with Aaron's are that the company will not be sold sometime soon or that the premium the company is sold for is minimal. Long term though, the company offers opportunity for the patient investor.

The past several years have not been good for any retailer that depended on the lower end of the consumer market. Slowly, the economy is picking up, and the consumer will take a more active part in it. I think that, long term, Aaron's can grow sales at about 7 percent and continuing earnings at 6.5 percent. More importantly, free cash flow will grow at about 100% per year.

The company pays a miniscule dividend that yields just 0.3% based on an earnings payout of only 4.5%. The company's cash payout is only 2.4%. Clearly, there is room for the company to boost the dividend. Aaron's also has in place a small share buyback program. I am not ordinarily a big fan of share buybacks; management should find a better return on the capital.

If Vintage Capital is not the successful bidder, then perhaps another buyer will emerge with a richer offer.

Disclosure: I am long AAN. 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.