ALCO Stores, Inc. (ALCS) is a regional broad lines retailer which operates 213 stores offering 35,000 SKUs and trades at a significant discount to its private market value and tangible book value per share.  Prominent value investors control enough of the shares to ensure that the value is realized in relatively short order.

Let’s cut to the chase here.  Last July ALCO entered into a go private merger agreement with Argonne Capital Group at $14.00 per share.  Later Everbright Overseas which owns 19% of the shares made a bid at $14.45 which the company rebuffed.  Michael Price (owns 8%) wrote a letter in August saying the merger price was too low.  The board and proxy advisory firms supported the merger, however, at the special meeting on October 30^th, 2013 the merger failed to secure the majority of votes (only 39% of the shares voted “yes”) required to complete the transaction.  Fast forward a mere quarter later and ALCO now trades at $8.82 a nearly 37% discount to the price not one, but two buyers would be willing to pay to acquire control of the company.   Smart value investors including Michael Price, Scott Barbee of Aegis, and Heartland Advisors own enough of the company together (28%) to ensure a good outcome here.  Everbright does not control enough to block a deal with another party, but they do have enough shares to make a deal with them most likely at a higher price.  The board of directors/management is going to be under duress to maximize value from all sides.

I’ll be the first to admit that ALCO is a cigar-butt stock.  It was written up on VIC in 2002 and 2004 (search ticker DUCK – it was formerly known as Duckwall-Alco).  The thesis was generally the same as it is now.  This underperforming retailer is too cheap.  It has a ton of money wrapped up in inventory and could be liquidated near current prices.  It has a lot of upside if it gets turned around and earns reasonable ROEs.  There is somewhat of a moat around the business because they operate in very small markets that few competitors would be willing to open a new store in (however dollar stores are a tough competitor so this is not a very big moat).  Having shopped at a few of these myself, they are kind of like a mini Wal-Mart in a rural area.  While you could drive an hour to the big city and pay less at a bigger chain, most of the time convenience trumps low prices for smaller purchases.  The average ticket of around $30 bears this out.  For the 10 years since its last appearance on VIC, it has been a value trap.  MFP and Heartland were both involved as far back as 2004.  It has been a long wait.

So what has changed?  The main thing that has changed is that the company is now firmly in play.  Argonne is a legitimate player in retail and restaurants: http://www.argonnecapital.com/ .  Everbright is a somewhat mysterious BVI company controlled by Chinese owners, but they clearly have money.  They bought the ALCO shares and they previously tried to acquire Gottschalks, a department store focused on small markets like Alco’s, in 2008.  That deal eventually fell through when Everbright terminated it after performing due diligence.  It turned out to be a good call as the company later liquidated in bankruptcy.  Based on this press release: http://maderaindustry.org/mcedc_oct08/Gott.pdf Everbright intended to help Gottschalks improve their sourcing out of China, something which could probably benefit ALCO as well.

I believe the long-suffering value investors probably also want to exit this position if they can get a fair price for it.  I think it is safe to say for the folks involved for 10 years the IRR here is not going to be very good (unless they sold a bunch in 2006-2007).  Price himself said he wants to sell the company in his August letter, but after the margins have been improved: 

"MFP Investors believes that the merger consideration of $14 per share is inadequate and grossly undervalues the Company. Alco’s book value per share is over $30 and its current assets minus current liabilities and long term debt/capital leases is $16 per share. While the merger agreement gives the Company the right to seek a higher bid from third parties, the go- shop period is too short to give the Company any meaningful opportunity to find realistic alternatives. The transaction requires the affirmative approval of a majority of the outstanding shares of Common Stock. The Company will not be obligated to pay a termination fee if shareholders fail to approve the transaction and no alternative transaction is consummated within a year of such disapproval. MFP Investors believes that the shareholders should vote against the proposed merger and that management should focus its efforts to first improve Alco’s margins and then conduct a robust sales process to maximize the value of the Company."

The value is undeniably still there.  As of November 3, 2013 the company had $213.7 mil worth of current assets including $194.1 mil of inventory, $12.1 mil of receivables and $2.9 million of cash on hand.  Total liabilities are $184.3 million.  The company turns its inventory a little over 2x per year.  Certainly not great for a retailer, but definitely enough to suggest that the inventory has value.  There are only 3.258 million shares outstanding so current assets minus total liabilities is $9.02 per share.  While the company may destroy some value if it doesn’t get sold, the margin of safety here should be quite substantial with this kind of asset coverage for the equity.  These metrics should look even better as Q4 is usually a cash flow generative quarter for the company.  The credit line with Wells Fargo doesn’t expire until July 2016, so the company has lots of time and no near term credit event risk.

In terms of the income statement, the potential is there.  Gross margins have steadily declined to the high 20s from around 33% over several years.  SG&A has been running in the high 20s which is too much.  Profits have been negligible. Sales have grown, but they have not kept pace with the industry.  Total sales are tracking to around $475-$500 million per year.  All the company needs is some margin on those sales.  Management recently moved the HQ of the company from Abilene, KS to Coppell, TX (a suburb of Dallas) in an effort to upgrade the talent running the show operationally.  The jury is most definitely still out on whether or not the margins will get turned around, but there are certainly people who think they can run this business profitably based on the private market interest. 

Can the current management team/board turn things around?  I am not sure.  Current management has been at it for four years so far without much success.  They are, however, somewhat shareholder friendly.  They bought back 12% of the company at $6.60 per share in Q3 of 2012 and then went on to find a buyer at $14.  Not every board/management behaves this way.  In terms of incentives, current management gets fixed based salaries ($455k for the CEO) and bonuses that are dependent on ROE each year.  Less than 3.5% ROE = no bonus and it scales up from there to 150% of salary for the CEO at ROE north of 17.5%.  They have options struck at prices ranging from $9.43 to $17 (most at $9.43). The CEO has exposure to 155,000 shares, so not exactly a huge incentive to sell out.  The loss on the vote at the special meeting should remind them who is in charge and keep them looking out for shareholders' interests.

In terms of what ALCO could be worth.  $14 is a good starting place for a strategic buyer.  If you think they can turn it around and eventually generate even 2% operating margins on $475 mil in sales, then the EPS power could be well north of $1.60.  Put a 12-14x multiple on that and a $20 stock is absolutely reasonable.  Of course, all that depends on getting margins up, which so far has been a challenge.  Note the 2014 values I use in the write up were lifted from the company's own estimates used in the M&A process available in the proxy filed on Oct. 1, 2013 on page 67.

Risks

1)      The ALCO consumer is a low-end consumer in a rural community.  50% of shoppers have income less than 40k per year, while 75% own their homes.  Crop prices and oil & natural gases prices matter to ALCO customers.

2)      Competition is a real challenge.  The resurgence and strong performance of dollar stores (which compete in 85% of ALCO’s markets) has clearly been a challenge for ALCO.  There are no direct broadline (e.g. Wal-Mart) competitors in 75% of their markets.

3)      Value trap.  This story has been a value trap for many years.  Only briefly in 2006-2007 did margins turn up and people believe in the story and bid the stock up to $40.  I believe the emergence of two firm bids for the company in the last several months bodes well for a happy ending to the story from here, but for years this story has been disappointing.  M&A opportunities may fizzle in the wake of the lost shareholder vote, but I do feel we at least have a good handle on private market value at this point in time.

4)      Obviously, this is a small and illiquid stock.  It is best suited for PAs.