Description

Summary
Chromecraft Revington (NTSE: CRC) is a small manufacturer of mid-priced residential and commercial furniture under several brand names. CRC is attractively priced on a fundamental value basis and has decent upside potential. It is a 15% ROE company with no debt and a 10% growth rate, and it’s selling for a 15% discount to book value and 3.8x depressed EBITDA. Citicorp Venture Capital owns 60% of the company, as they have since 1992. This is a very long time for a private equity firm to be in a deal (private equity holding periods average about five years). As a result, there is a greater than average probability of a change-of-control at a significantly higher valuation during the next few years.

Background
CRC was founded and taken public in 1992 by Citicorp Venture Capital, which currently owns 60% of the shares. The company was founded to roll-up and improve small under-performing furniture manufacturers. Citicorp Venture Capital started the company by merging two furniture manufacturers, and it has gone on to acquire three additional companies since being public.

In December 2000 Citicorp Venture Capital (through its unit Court Square Capital) made an offer to acquire the remainder of the company for $10.30 per share (3.6x 2000 EBITDA). At the time, it represented a nice premium over the share price (then at $7.00), which had declined 50% in the previous five months. The board neither accepted nor rejected the offer, and the company was essentially in limbo for seven months with no communication about the status of the offer. In July Citicorp Venture Capital pulled out, citing the “uncertain general economic climate.” This was obviously a bad signal and, in retrospect, Citicorp may have been right because profits have only deteriorated since. But, I think there were other circumstances that caused them to pull out.

The fact that the offer was outstanding for seven months struck me as unusual. The official reason for the delay was that Citicorp Venture Capital was conducting due diligence, but since they control the company and sit on the board, I doubt they needed to do much due diligence. Rather, I think the board was hesitant to let Citicorp take the company private at such a low price. In fact, three shareholder lawsuits were announced to contest the low offer price.

I have also heard some unconfirmed rumors that there were some changes going on at Citicorp Venture Capital that may have caused them to withdrawal. Specifically, I heard that (i) Citicorp Venture Capital was shifting from using the bank’s capital to raising funds from the outside like a traditional private equity firm, and (ii) that Citicorp Venture Capital was having a transfer price conflict issue because their original stake was held in a different fund from the one making the offer. This is a real conflict that private equity firms run up against. I want to emphasize that these points are totally unsubstantiated. I mention them only because some of you may be able to get better data (if so, please share).

I think the main take-away is that the majority owner of the company for the last nine years thought that $10.30 per share represented a very good value. Given that Citicorp Venture Capital knows the company well and that the company is in a fairly stable industry (see industry section below), I doubt they pulled out because they suddenly discovered some problem with the company.

Financials and Valuation
CRC has trailing 12-month sales, EBITDA and net income of $225 million, $27 million and $12 million, respectively. YTD, sales and EBITDA are down 13% and 19%. Before this year, CRC’s sales and profits have increased fairly consistently over the last eight years at about a 10% rate. Free cash flow (cash flow from operations less capex) has averaged $12 million per year for the last three years, not including the first nine months of 2001 when the company generated $18.8 million of free cash flow, primarily due to decreases in inventory. Returns on equity are in the 14% to 18% range, declining in recent years due to acquisitions.

At the current share price of $10.55, CRC’s market cap is $102 million with zero debt and negligible cash. It trades at 3.8x depressed EBITDA (3.1x 2000 EBITDA), 8.3x earnings, 8.4x FCF and at a 14% discount to book value. I like that fact that you can basically buy a decent ROE for a discount to book value.

For comparable companies, I look at similar-sized furniture manufacturers including Stanley, Bush Industries, Knapt and Vogt, Row and Falcon. This group has experienced roughly the same declines in sales and profitability as CRC in the last year. The last two names were over-leveraged going into the current downturn and they are now in trouble, so I leave them out of the analysis. The remaining group trades at 5.5x EBITDA and 1.5x book value – a premium over CRC despite the fact that they have similar historical growth rates and slightly lower average returns on capital. Based on the EBITDA valuation, CRC could trade above $15 per share, representing a 45% gain.

CRC also trades at a significant discount to its going private value. LBO firms have been fans of furniture companies in recent years because of their relative stability and the ability to borrow against their assets. Here’s recent LBO valuation data:
· Pulaski Furniture for $66 million by Quad C on 3/31/00 (5.9x LTM EBITDA)
· O-Sullivan Industries for $280 million by Bruckman, Rosser & Sherrill on 5/18/00 (6.4x LTM EBITDA) (Note: this buyout firm was founded by former Managing Directors at Citicorp Venture Capital - do you notice a trend?)
· Knoll Industries for $1.2 billion by Warburg Pincus on 5/24/00 (6.3x LTM EBITDA)
· Winsloew Furniture for $250 million by Trivest on 3/5/99 (7.4x LTM EBITDA)
Based on the average EBITDA valuation for these transactions of 6.5x, CRC would be worth $18 per share, or a 70% premium over the current price. In addition, there have been a number of acquisitions by strategic buyers, which tend to pay more than financial buyers.

CRC has been a large buyer of its own shares over the last few years. Here is the percentage of shares the company has bought back each year and the average price:
1997: 1.2% for $13.39 (split adjusted)
1998: 5.3% for $17.27
1999: 6.2% for $14.29
2000: 8.1% for $8.49
This shows good capital allocation in my view and reflects management's belief that the shares are a good value at even significantly higher prices. In addition, CRC used all its free cash flow YTD to pay down debt from $19 million to zero.

Industry Scuttlebutt
One view from an industry insider is that CRC’s share price has been unfairly beaten up and that the company is still psychologically in play. The company may become an acquisition target as the share prices of larger manufacturers improve and as the credit markets come back for LBO buyers. CRC is regarded for its exceptional manufacturing ability and the CEO has a reputation as a furniture manufacturing guru (the same management team has been in place for the life of the company). CRC should grow faster than the overall industry as it continues to improve the under-performing companies it has acquired. There is also a possibility that it could make additional acquisitions, especially because it has significant untapped borrowing capacity.

Furniture Industry
The take-away from the industry factors discussed here is that CRC’s business results over the next ten years will probably be similar to its results over the last 10 years.

The furniture manufacturing industry is mediocre at best. It’s mature, fragmented, very labor-intensive, and competition and chronic overcapacity have kept returns on capital at minimum levels. The two biggest factors impacting the U.S. furniture industry are the economy and Asian imports. Despite what one might first think, the furniture industry is not cyclical. In the last 30 years the industry has declined only three times, with a maximum contraction of 3%. Over the same period the industry has grown 7.2% per year compounded and demand has stayed at a relatively fixed percentage of personal income. Overall returns on book equity for the industry have trended between 9% and 12% for the last 40 years, with meaningful fluctuations between good and bad years (i.e. between 2% and 18%). All this being said, the furniture industry is literally experiencing its worst year out of the last 30 years, with sales down 10% to 30% for most manufacturers and retailers. The economy is the source of the problem, although it is confounding analysts that the low interest rates and the record rate of mortgage refinancing are not mitigating the problem more.

The biggest change in the industry is the increasing trend of Asian imports. Historically, the biggest barriers to Asian imports have been poor quality and cost of shipping (due to furniture’s low value relative to weight). Major vertically integrated U.S. furniture manufacturers/retailers such as Ethan Allen and La-Z-Boy have been reducing these barriers by teaming up with high quality plants in Asia and by taking advantage of economies of scale to reduce shipping costs. This is a very real trend and it represents a partial wake-up call for U.S. furniture manufacturers. But, the U.S. furniture manufacturing industry is not about to go extinct. The reason is that only the largest furniture retailers have the scale to fill-up shipping containers in order to justify the cost of importing. The retailer base in the U.S. is extremely fragmented, with the top ten players controlling just 16%. Furniture retailing is a mom-and-pop business, with the average retailer generating sales of $3 to $4 million. As a result, most of the retail base in the U.S. lacks the sophistication and scale to import from Asia.

Negatives
CRC is a very illiquid company with average daily volume of 5,000 to 10,000 shares. In addition to Citicorp Venture Capital’s 60% stake, T Rowe Price owns 10%, so the true float is only $30 million.

Catalyst

CRC is cheap on a fundamental value basis and there is potential for a change-of-control at a significantly higher valuation.