Children’s Place (“PLCE”)is a specialty realtor trading at
less than 4.5x 2008E EBITDA. The stock
has struggled in the last as management/merchandise resulted in a significant
reduction in earnings guidance. This has
given us the opportunity to buy a leading specialty retailer with new store ROI
in the mid-eighties. The company has
years of significant square footage growth; and margins should double from the
current depressed levels. And if the
public market doesn’t figure this out quickly, the former CEO, Ezra Dabah, has
been rumored to be interested in bidding for the entire firm.
Summary of the
company:
PLCE is a specialty retailer whose “goal is to be the
leading specialty retailer in the children’s space”. PLCE runs two store concepts: The Children’s
Place and The Disney Store.
The Children’s Place focuses on children from newborns to
approximately 10 years of age. The
majority of the merchandise is value priced, with some better/best
options. Product is sourced pretty
efficiently abroad, with the company having several sourcing offices in Hong
Kong, Shanghai and New Delhi.
The concept is expected to have about $1.5 bn in sales this year and
approximately 920 stores. The average
store size is about 4700 square feet, and the company is in the midst of
changing the store format to have wider aisles (to accommodate strollers) and
brighter displays. About a third of the
stores have been remodeled to date, with very solid results from these
“Technocolor” stores. The average new
store net investment was $466,000 in 2006, and the average cash flow for new
stores was $407,000 in 2006 for a very impressive store level cash on cash
returns.
The Disney Store was purchased from Disney in 2004 for
basically the cost of working capital. This was a transformational deal for PLCE,
adding about $500 mm in sales to their sales base, and over 300 stores. In exchange for a cheap price, PLCE signed a
royalty agreement that gives Disney 5% of all sales as well as the ability to
pull the license to the “Disney” name if a number of hurdles are not
reached. This license requires a minimum
amount of capex to be spent remodeling the current stores as well as building
new ones. There are limits on the
amount/type of promotions that may be run, and there is a change of control
provision as well. However, there is a
limit to PLCE’s corporate exposure in the event the Disney operations cannot be
turned around. The license and royalty
agreement were signed by a subsidiary of PLCE, “Hop”. In addition, the lease signer is “Hop”, not
PLCE. PLCE has an agreement with “Hop”
to fund a certain amount of the capex upcoming, but that amount is capped. The rest must be self funded by the
subsidiary. As a result, I believe that
PLCE can file “Hop” for bankruptcy and creditors will have no real recourse to
the healthy Children’s Place chain. Given
the structure and price of the deal, The Disney Stores remains a very valuable
option to PLCE for future growth.
Recent Troubles
Lack of SEC Filings
For the past year, PLCE has not had current SEC filings as
its accountants worked through whether options had been properly granted. As Deloitte & Touche worked through the
accounts, other examples of poor internal controls appeared, including several
inappropriate transactions on the part of senior management. These included the CEO forgetting to report
an increase in his wife’s shares due to a disposition from the trust and his
using PLCE stock as collateral to a margin account during the blackout period
for management trades. PLCE is now
current with its filings, but it still has some internal control problems,
presumably the reason why Deloitte & Touche resigned from being the auditor
for the upcoming fiscal year.
Loss of CEO
As a result of the above transactions, the board asked Ezrah
Dabah to resign on 9/24/07. Ezrah was
deeply involved in the running of the company, and as a result his departure
was a real shock to the employees. News
reports imply that Mr. Dabah is extremely upset he was asked to leave the
company.
Disney License violations
PLCEs’ first attempt to remodel the Disney Stores, the
“Mickey” format, was an unmitigated disaster.
Disney didn’t like the design and the performance of the stores was
sub-par. As a result, PLCE abandoned the
format and wrote down the fixtures; unfortunately, this was after about 40
stores had been moved to the “Mickey” format.
As a result, PLCE ended up in violation of the licensing agreement which
required a certain number of remodels to be complete by the end of 2007. This disagreement was recently resolved with
PLCE agreeing to invest $175 mm in remodels/new stores over the next three
years. In exchange, Disney is allowed to
terminate the license agreement at will if PLCE does not comply. However, despite the harsh language, Disney
seems to be willing to work with PLCE ~ giving them a waiver just three months
after the agreement was signed. (PLCE is
not able to meet the remodel condition for 2007, and thus Disney is waiving the
condition).
Poor Results
The company had a fantastic 2006; comps were 11% overall,
with 10% comps at Children’s Place and 14% comps at the Disney stores. The company was literally chasing inventory
the entire year at The Children’s Place. The Disney store was benefiting from the
release of Cars, which obviously was not replicated this year and hurt results
substantially. For The Children’s Place
concept, management increased their inventory budget for 2007, just in time to
face bad weather, and a slowing consumer.
At the same time, they decided it was a brilliant idea to raise the
initial markup. As a result, Children’s
Place has spent the entire year marking down inventory, and bringing down
guidance.
Now, in the last inning of the year, the company has
withdrawn Q4 guidance, and is not giving any commentary with regards to
2008.
Numbers
Stock
Price
|
$27.36
|
|
Shares
|
29.084
|
|
Options
|
1.26
|
|
Strike
|
$22.92
|
|
Diluted
shares
|
29.289
|
|
Equity
value
|
$801.3
|
|
Less:
Cash
|
(111.2)
|
|
Less:
Seasonal Cash
|
(50.0)
|
|
Plus:
revolving loan
|
108.9
|
|
Enterprise value
|
$749.0
|
|
|
|
EV/EBITDA
|
LTM
EBITDA
|
$170.9
|
4.4x
|
2007E
EBITDA
|
$131.9
|
5.7x
|
2008E
EBITDA
|
$161.1
|
4.6x
|
Thesis
Children’s Place holds a solid place in its market. It has competed effectively with Walmart,
Target, department’s stores, gap kids, etc. by offering a fashionable value
alternative in an easy-to-shop environment for Children. The Disney stores, while poorly run in the
past, are slowly being turned around by new leadership brought in at the end of
2006.
The valuation is obviously discounted for the above
reasons. It has been a tough year for
the company, but the current valuation is at a ridiculous discount. Several of the above issues are completely
solved: the Disney violation has been resolved and the SEC statements are now
filed. The other issues, I view more as
opportunities. This is a company that
lost 550 bps of gross margin due to markdowns, all of which will be annualized
next year. The new merchandise in the
stores is already resonating better with the customers, as evidenced by solid
November same-store-sales numbers. Given
the value price point, consumer strength should not be issue for this company,
which despite increased markdowns, has had solid traffic and transaction growth
the entire year. As a result, it is
possible that earnings will grow at least 30-50% in the upcoming year, even
with a poor economy.
The second issue, the loss of the CEO, may result in a bid
for the company. By all reports, Ezrah
Dabah was a passionately involved CEO that was extremely upset by the board’s
request for his resignation. On
10/15/07, Ezrah filed a 13-D stating he had hired Bear Stearns to evaluate
strategic alternatives with regards to his PLCE stake ~ one of the alternatives
being a potential bid for the rest of the company. If you run the company through an LBO model,
and assume that the FY ’06 margins can be re-attained in three years, you can
get a mid twenties IRR at $32 with only 2.5x total debt to EBITDA. In order to do this, Ezrah would need to find
a partner to put in about $400 mm in capital.
However, with mid twenties returns assuming a conservative exit multiple
of 6.0x EBITDA, it shouldn’t be hard to find some private equity money that is interested.
Target Price
If there is a bid in the next couple of months, I believe
it’ll be in the $30-$35 range given a conservative LBO model and limited
financing ability. While this should
provide nice support for the stock, the true value of the company is much
greater. If you normalize the margins,
and assume an average specialty retail multiple, this stock should be worth in
the mid-sixties.
2008E
Children's Place sales
|
1,600.0
|
2008E
Disney sales
|
680.0
|
|
|
'06 EBIT
margins for Children's Place after overhead
|
10.3%
|
Assumed
Margin for Disney after overhead
|
3.0%
|
|
|
Normalized
EBIT for Children's Place
|
165.3
|
Normalized
EBIT for Disney
|
20.4
|
Total
EBIT
|
185.7
|
D&A
|
82.0
|
EBITDA
|
s267.7
|
08E
EV/EBITDA multiple
|
7.0x
|
Enterprise Value
|
1,873.6
|
Equity
Value
|
1,926.0
|
Per Share
|
$65.76
|
Risks
1) Fraud
~ given the large number of management departures and the comments by Deloitte
& Touche, it is possible that there are more serious issues in the
books. However, given the valuation is
around 0.5x sales and the company is currently net cash, there seems to be
limited downside from here.
2) More
merchandising mishaps
3) Lack
of committed leadership. None of the
senior managers have been at the company for more than a year. The President of Children’s Place had been
there longer, but he resigned a couple of weeks ago in order to become the
President of Zales.
4) Poor
Q4 results
Catalyst
1) Improving
sales trends in 2008 leading to better margins
2) Better
Disney release schedule in the upcoming year.
3) Bid
by former CEO ~ Ezrah Dabah.
3) Bid by former CEO ~ Ezrah Dabah.