Description

With less than a month for my VIC membership to expire and sort of overwhelmed amid the requirements to set up an investment vehicle in Spain, probably the last thing I expected was finding a great investment. As ironic as it seems Calloway’s Nursery is on my messy desk. 

CLWY operates 17 garden centres – 10 owned + 7 leased – in Texas, particularly in the Dallas-FW and Houston areas. More than $40B annual sales make the US gardening market very large - Texas ranks 3^rd. Large and competitive. Most customers are price-sensitive and the large big-box discount retailers as Wal-Mart and Lowe’s picked their spot in the market long ago. When CLWY started-up in 1986 its founders had the wise vision of capturing the upper-end of the market. Building up very few stores and offering a great experience for visitors, which in turn would increase CLWY’s pricing power by setting itself apart from hard discounters and by attracting wealthier clientele.

Then it happened what usually does. In the early 90s the founders drifted. Rather than improving the operations and value proposition in the existing store base they impregnated CLWY with a culture driven by acquisitions and aggressive store growth, diluting their customer base and sacrificing value for price. Just imagine competing with Wal-Mart on price grounds. Interestingly Amazon is less of a disruption force in this market as plants are not fungible, meaning you are less likely to buy online something that is not exactly the same product you saw in the store and even less likely to order blindly online. Flowers to your wife or girlfriend sure not included!

The store count peaked in 2006. Remarkably CLWY made less money in sales back then with as many as 26 open stores than now with just 17 stores in operation , which translates into <$2m per store sales in 2006 vs. ~$3m now. The mismanagement led to operating problems, inexistent EPS growth for the last ten years and a pile of debt. Luckily a terrific activist investor has been pressuring the management for long and has at least managed to reduce the debt burden and close and divest the uneconomic units (more on this later).

CLWY is virtually out of any radar as a result of its $20m market cap but especially of its <300 shaholders, making the company exempt from virtually all teh SEC's reporting requirements. Non-recurring items make the last 10Q-s messy. The uneven metrics at the store level, some loss-making and some profitable, also contribute to hide the true earnings power.  

Especially misleading is the last Q4 file. 2015 reported EPS comps poorly with 2014 numbers amid the sale of one unprofitable retail store. I think $8.8m gains on $9.1 cash proceeds might give you a sense of the existing gap between CLW’s real estate balance sheet values and the actual ones. Sure the gap on every property varies depending on acquisitions dates, historical write-offs and land location but I think the data bodes well for my purpose of showing you the magnitude of such understatement in some cases. The stock plummeted upon releasing 2015 annual numbers. One reason for this are the poorly understood reported numbers which showed a >80% EPS free fall. Unadjusted. Adjusting for non-recurring items EPS just dropped from $0.25 to $0.19.

You might wonder how such a simple issue might motivate investors to sell. OK. Do not think about “properly” sell-side covered companies. Just think about a company stock trading in the OTC Pink Sheets, its typical investor base and some people who push some others to “own” its shares. With a total disregard for fundamentals, these promoters make the most of any change in reported numbers to have a “reasonable basis” in order to make the story they need to generate fees out of turnover. For more info on this practices I suggest you give a call to Jordan Belfort.

The Wolf of Wall Street modus operandi just explains a small part of the story though. Peter Kamin is the most important factor that explains the recent volatility in the stock price. ¿Who is Kamin? Briefly speaking he is an extremely successful investor in small companies, who co-founded Value Act, left to start his own shop 3K and has been long time shareholder in CLWY.

As a value oriented investor Kamin got finally fed up with the forever-growing management style of the founders. Central to the thesis, on February 3K and CLWY jointly completed a tender offer to buy half of CLWY’S stock for $2.52 per share. The transaction served well for Kamin purposes of owning more than half of the company and kicking out the incumbent managers, who get rid of all their holdings. So after tendering, a terrific owner-operator owns 57% of the shares, the bulk of his investment breaks-even at $2.52 close to the $2.72 current price and he runs a concentrated portfolio with just 5 investee companies. For whatever is worth for you the fact of being aligned with Mr Kamin. For me is truly worth a lot.

The downside is that from now onwards disclosure will be very limited, sticking to the minimum reporting requirements and there is the real risk that 3K takes the company private offering a relatively low price for the remaining shares. Q1’16 report is not even posted on the company website. Interestingly the tender offer has significantly reduced the share count by 15% or so. CLWY has 7.35m shares outstanding and sells for 2.72$ per share, which makes for $20m market cap. Net debt is ~$15m after adjusting for operating leases and DTLs, so EV is $35m. Normalized pro forma EBITDA is m$5.5-6 so CLWY is selling for 6x EBITDA.

Book value is $18m. As the company has already written-down historically the underperforming assets, my best guess is the book value is quite solid. From this perspective CLWY is selling for 1.1x book. The book value seems to significantly understate the fair value of the assets as I explained before. These numbers do not ascribe value to the owner operators and their value creative initiatives, which may well comprise additional monetization of assets, buying back more stock and even the use of the excess cash in the future to fund receivables. 

Catalyst

-  Shareholder oriented and value creative new management team after succesful tender offer

-  Improving operations and monetization of less profitable and loss-making units 

-  Converting leases into actual ownership and paying down the associated debt as it has happened so far

-  3K offering a good price for remaining shares and CLWY going private