Description

Boyds VIC
KKR LBO’d Boyds (FOB) as a private company in 1998, at about 8.6x ev/ebitda, and less than a year later took the company public at 11.5x ev/ebitda. Since the IPO the stock has fallen -80%, the stock has fallen another -64% from where management bought back stock 2 years ago, now the company has paid down its debt 70% and book value is up +645% since the IPO (.33 to $2.45). The company has considerable earnings power, from 1997-2002 the company earned $307 million in net income or about $5.20 a share, 50% higher than where the stock currently trades. KKR still owns 59%, the former company founder holds 17%, and past/current CEO own 1.5% (Current CEO has bought over 200,000 shares last 12 months @ $3.40 +/-).

I believe the company is at a very key inflection point for creating significant shareholder value over the next couple of months and years. The business is attractive due to strong operating leverage (estimated 32-45% top line w/25%+ EBIT margins, co averaged 45% Operating margins ’99-’02, with only wholesale concept), straightforward business, high barriers to entry (brand/trademarks/copyrights/user base), new management (12 months on job), and most importantly the roll out of retail strategy. Wholesale is a great business while I think given the company’s model, Retail is an exceptional business (in 2003 company ran @ a 33% retail operating margin).

If my projections are right, I think the company is trading at about 5x ev/ebit on 2005, with a significant long term revenue driver with significant earnings power. If my ’05 number is right, FOB trades for 38% less than where KKR bought as a private company in higher rate environment in 1998.

I think the stock could see a take out between $6.50-9.45 in 2005 or (8.6-11.5x what KKR paid to what IPO valuation). The difference now from IPO, is that Boyds has two channels of distribution, a new sustainable strategy, with better margins than wholesale.

In a nut shell, the company should run at 30% Operating margins for 2005, with 32-45% top line growth (with nothing exceptional to get there), and at current valuation 5x ev/ebit.

Board is strong, Ed Artzt, former CEO of Proctor & Gamble, Henry Kravis, KKR, Jim McCann, CEO of 1800flowers, Gary Lowenthal, founder of FOB. KKR has significant board influence as one might expect holding 5 out of 10 board seats.

The CEO appears to be solid based on industry experience and strategy that she is pursuing. Jan, worked for P&G for 20 years, Hallmark for a few years, BA/MBA Northwestern, and on the board of Clorox.

Management has realized that the collectable market is severely challenged due to EBAY, Wal-Mart, Target, etc, so controlling the consumer experience (from beginning to end) is an essential part for success. Recent IPO Build-A-Bear (BBW) (FOB comp) highlights this, BBW describes itself as “an interactive, entertainment retailer of customized stuffed animals.” This key differentiator has really paid off for BBW in their results (20 million bears sold since 1997, 41% annual growth, with significant margin expansion). Wall Street has readily embraced the BBW concept valuing BBW @ 19x ev/ebitda. BBW is mall based with much smaller locations and higher sales per sq foot, which is no surprise, but pays much higher rents than FOB. FOB estimates that Gettysburg store would make top 50 locations in US, based on traffic but obviously not one of the best locations, Gettysburg store does $15-16mm per year which is 10x that of average BBW store. The average FOB square footage of a store is nearly 30x the size of BBW, with better economics and much cheaper space. FOB owns the land and the stores for the first two locations currently open.


1 in 4 people that visits Gettysburg, Pa (2,000,000 a year) buys something from Boyds store there (500,000 visits a year with Average spend per customer is $32 or about $16,000,000 a year in total revenue).

Retail concept:
Each new store costs $15,000,000 to build, which includes a Restaurant that seats 500 people, ice cream parlor, coffee shop, giant fireplace, and 25 foot x-mas tree inside (they sell baked potatoes with various toppings for 1 that range from $4.75-$5.25 each), make your own bear, local bands/entertainment that play on weekend. The typical visitor is on a day trip/vacation and usually spends 3-4 hours in the store.


Boyds estimates that about 1,000,000 will visit Boyd’s Pigeon Forge location in its first year. The company feels like the lay out and revenue opportunity per visitor should be as good or better than Gettysburg due to the two year learning curve (product placement and features customers like). This million number might be on the low end given, that 25% of people that visit FOB in Gettysburg buy something from the store while the FOB in Pigeon Forge only assumes about 7.1% of visitors stop and buy from the store. About 14 million people will visit Pigeon Forge this year, which is one day’s car drive within 2/3 of American population.

The company plans on rolling out two other very attractive locations in 2005: Myrtle Beach, South Carolina (11 million visitors FOB has great location there at Broadway @ the beach) and Branson, Missouri (7.5million annual visitors, country music hall of fame).

Retail Concept
500 seat restaurant
Live entertainment daily
Estimating about 1,000,000 come to store per year
100,000 sq foot store
Costs about $15,000,000 to build
33.5% OM ’03 retail, retail margins vs. 22% for wholesale
Avg visitor buys about $32 per visit

Just with Pigeon Forge company should add incremental revenues of $32mm assuming no improvement over Gettysburg, which would imply 28% top line growth. However, Myrtle beach and Branson are slated to open in late 2005, which will produce incremental revenues of $2-14mm, depending on schedule, which could push growth to +40%. Gettysburg in first year did $6.2mm in 4 months of operation in 2002.

VIC member alex949 in April ’02 wrote up FOB at $7.40, I suggest if interested going back and reading his solid write up regarding, brand equity and a loyal customer base (company celebrated its 25th anniversary this year).

Valuation:



ev/ebitda ev/revs rev growth OM ROE D/TC
BBW 18.4x 2.04 44% 11.2% 36.1% 0%
BEAR 6x .46 39% 7% 23.8% 26%
FOB‘04E 18x 2.6x +0.9% 21% 4.2% 27%
FOB‘05E 4.9x 1.5x +32-45% 31% 26% 36%

FOB EV= $271, BEAR EV=$25, and BBW EV= $588

Insider buying
4 Aug ’04 CEO 10,000 shares $2.55
4 May ’04 CFO 3,000 shares $2.90
3 May ’04 CEO 100,000 shares $2.86
1 Dec ’03 CEO 100,000 shares $4.30
4 Nov ’03 Dir 2,000 shares at $5.05


My DCF model shows that the market thinks that the company will never get over 20% EBIT margins, and revenues will at annual growth rate of 5.5% for the next 20 years. I see a very different future given the company’s most recent quarter 25% OM, I think we will see significant growth from retail roll out, with significant margin expansion.

FOB averaged $57mm in EBIT in both 2001 and 2002> before transition, new management, and strategy. $26mm ’03 and $26mm ’04

Last quarter FOB got to 25.3% EBIT margin, with positive comps in Wholesale, now is a key inflection point for FOB. The new retail superstores are up and running and the role out is set for 2005. Margins for Wholesale vs. Retail details

Over the past few years, FOB Operating Margins have declined from an average of around 40% to the current level of 20-25%. During this same period gross margins have held constant at 60% of sales. Thus, the decline in operating margins can be explained by significant increases in SG&A. SG&A has increased from a historical run rate of 20% to around 35%-40% in ’03 and ’04.

A perfect storm of events brought this SG&A number to its present level. A number of extraordinary charges including changes in management, restructuring of the sales force and increased overhead due to ramping up of retail business collectively drove the SG&A higher. Though negative in their impact to current margins, these changes will have positive ramifications for Boyds long-term.

The management shakeup is over and the new team is moving the company in
the right direction. They recognized that the incremental sales generated by a large field sales force were not worth the amount of effort and cost being expended to generate those sales. So, they eliminated 73 field sales positions and replaced them with a centralized 35-person customer service group, which will save $3 million a year. The remaining field reps will focus solely on large accounts, generating significant sales per rep while the smaller accounts totaling less than $5000 per year will be serviced by the customer service group. Boyds’ internal research indicated that such an arrangement is how smaller accounts prefer to be serviced anyway.

The retail business is still in its infancy and Boyds is making considerable monetary investments in the concept. As this new distribution channel gains traction and matures, the operating expenses as a percent of sales will decline. Due to the Boyds current momentum and leverage in the new operating model I expect SG&A to return to normalized levels in the 25-27% range within the next two years. My model suggests that operating margins should move 31.8% ‘04E and 39.3% for 2006E.


Disclaimers: I own shares. I may buy or sell whenever I like. This is not a recommendation to buy or sell.


Company bought back 2.83 million shares at average price of $9.68 a share about 2 years go (+184% where stock currently is). Neither KKR (owns 59%) or Gary Lowenthal (owns 17%) sold any stock back to company. The company also has an attractive deferred tax asset that will shield significant amount of earnings over the next 20 years

Catalyst

Catalysts
a) Very strong operating leverage, 25%+ OM and est 35-50% revenue growth p/e 6.8 and 5x ev/ebit with only 2 stores open for full year 2005 and 2 less than 4 months of ‘05.
b) 1 new retail store open 4 nov ’04, 2 more coming in ’05 (myrtle beach, sc and branson, mo(should do at least $22mm per store per year), store level ran 33% OM ’03,
c) if ’05 number right stk 38% cheaper than what KKR paid in ’98 with much cleaner b-sheet, and growth plan
d) News on Pigeon Forge store coming qtr
e) Wall Street realizes: FOB has far better economics/growth potential than BBW, closes valuation GAAP