Lumber Liquidators (NYSE:LL) went up significantly in late September, with its rise attributed to some unsubstantiated takeover rumors. Given Lumber Liquidators' still high short interest, it is not surprising that it can spike on rumors. However, I believe that it is unlikely that Lumber Liquidators could attract a $30 bid (as was rumored). Typical buyout premiums compared to Lumber Liquidators' price at the time would be closer to $18 to $20 per share, which would be a fair valuation for Lumber Liquidators if it can get past the multidistrict litigation with minimal damage and can also return to modest sales growth and 36+% gross margins again.
Notes On Takeover Rumors
The takeover chatter has happened before, with a June 2015 rumor that Home Depot could buy Lumber Liquidators for $35 to $40 per share (when it was trading for around $20 to $21 per share before the rumor). Obviously that rumor proved to be unfounded, but it did contribute to a 4% increase (and a intraday high that was 12% above the previous close) in Lumber Liquidators stock on heavy volume. Lumber Liquidators went back down to its previous price pretty quickly since it was extremely unlikely that an acquisition offer would be made when the company was embroiled with legal challenges and controversy. There was also some private equity talk in December 2015.
Now that some time has passed and many of Lumber Liquidators legal issues have been settled or dismissed, there probably is a greater chance that an acquisition could happen. I believe that an acquisition is still unlikely until the multidistrict litigation is fully resolved. As well, any potential acquirer would need to be comfortable with Lumber Liquidators' gross margin situation going forward. Lumber Liquidators has not been able to provide clarity to investors about what its long-term gross margin outlook is, although there is some expectation that long-term gross margins could be around 36% to 37%.
Although Lumber Liquidators still generates nearly $1 billion per year in revenue, its valuation is more dependent on profitability. Lumber Liquidators traded for an enterprise value of around 7.7x forward adjusted EBITDA in early 2012, when there were expectations for around 6% net sales growth and roughly flat (slightly positive or negative) comparable store sales growth. It traded for around 9.6x forward adjusted EBITDA in early 2011, when there were expectations for around 15% net sales growth and low-to-mid single digits comparable store sales growth.
Based on those multiples, Lumber Liquidators would need to generate $71 million in adjusted EBITDA to be worth $18.75 per share at a 7.7x multiple and $57 million in adjusted EBITDA to be worth its current price at a 9.6x multiple.
To be worth $30 per share at a 7.7x multiple, Lumber Liquidators would need to generate $112 million in adjusted EBITDA. To be worth $30 per share at a 9.6x multiple, Lumber Liquidators would need to generate $90 million in adjusted EBITDA.
I have thought in the past that Lumber Liquidators might be able to slash SG&A some more in order to reach/improve profitability. However, even after excluding all the irregular items such as elevated legal and professional fees, it looks like Lumber Liquidators might still have a minimum of $325 million in SG&A per year. This is around 3.5% greater than 2014's $314 million SG&A total, but isn't bad given that Lumber Liquidators now has around 13% more stores than 2014's average store count. As well, inflation (however modest) would increase costs as well. Excluding depreciation and amortization as well as stock-based compensation may bring this down to around $305 million.
Thus to get $57 million in adjusted EBITDA, Lumber Liquidators would need to generate $362 million in gross margin. This could be accomplished with $1 billion in sales and 36.2% gross margin. To get $71 million in adjusted EBITDA, Lumber Liquidators would need to generate $376 million in adjusted EBITDA. This would require $1 billion in sales and 37.6% gross margin or $1.04 billion in sales and 36.2% gross margin.
For Lumber Liquidators to get to $1 billion in sales would require low-single digits comparable store sales improvements from current levels. This is a pretty reasonable target for Lumber Liquidators in my opinion. To get to $1.04 billion in sales instead would require mid-single digits comparable store sales. I think a 36.2% gross margin level may be achievable, although a 37.6% gross margin level may be fairly challenging. Overall, Lumber Liquidators' current share price looks potentially justifiable in the long term, although it needs to avoid incurring significant additional debt (from operations or any legal settlements).
However, to get to $90 million in adjusted EBITDA, Lumber Liquidators would need to do $1 billion in sales with a 39.5% gross margin, or $1.091 billion in sales with a 36.2% gross margin. This would require double-digit comparable store sales growth from current levels. To get to $112 million in adjusted EBITDA would require Lumber Liquidators to do $1.056 billion in sales with a 39.5% gross margin or $1.152 billion in sales with a 36.2% gross margin. I can't see a $30 offer being a reasonable expectation since any acquirer would need Lumber Liquidators to make a rather major improvement in sales just to make $30 a fair value for the company. Given the damage to Lumber Liquidators' reputation, it is unlikely that it would command a premium (significantly above fair market) valuation from any potential acquirers at this point.
Lumber Liquidators has been involved in vague takeover/acquisition rumors several times now, and so far nothing has come of those rumors. The multidistrict litigation would appear to be a barrier to any sale of Lumber Liquidators until it gets settled anyway. I also have a hard time envisioning a $30+ offer coming in for Lumber Liquidators given the very large business improvements that would be needed for any acquirer to come out ahead when paying that type of price.
Lumber Liquidators' current price of around $18 to $20 looks potentially supportable if it can get back to 36+% gross margins and also deliver modest comparable store sales growth. However, this valuation also assumes that Lumber Liquidators will not suffer significant cash burn from ongoing business losses or any multidistrict litigation settlement. I don't see too much upside for Lumber Liquidators from current levels for the next year or more, other than a potential spike from a positive resolution of the multidistrict litigation. Downside risks involve a negative result from the multidistrict litigation as well as a slow recovery in Lumber Liquidators business metrics.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.