Description

Franklin Covey is selling for less than its net liquid working capital, and has been under massive selling pressure this week. A couple of days ago, they were kicked out of the S&P 600 index and around 1 million shares are in the process of being sold at what looks to be “at any price”. FC’s stock price has fallen recently from around $2.30 to about $1.10. This is just too cheap regardless of the perception that this is a crappy, outdated business. As a short-term trade, this is very timely. As a longer-term turnaround situation, it is certainly worth a hard look.

With 16.1 million shares outstanding (net of it loan program shares being confiscated in 2005), Franklin Covey’s effective market cap is only about $17.7 million. As of June 30th, Franklin Covey had about $47m in cash on its balance sheet, real estate and printing operations that are going to be sold (within the 18 months in my view) worth about $40m and liquid net working capital of around $25m. Management’s guidance calls for them to be about cash flow breakeven on its current sales of around $335m. They have about $87m in convertible preferred stock outstanding that they have to pay 10% on (converts at $14/sh), so FC’s cash and real estate assets nearly exactly offsets that obligation. That leaves about $25m in liquid net working capital for the price of $17.7m.

So what are we left with? A company that has slashed its SG&A significantly over the past couple of years (which is estimated to come in around $185m in fiscal ’03 ending 8/31/03), a much more focused company than in the past, and one that has a lot of operational leverage going forward. With gross margins of around 59% and SG&A of around $185m, we have a company that on its current sales of $335m produces positive EBITDA and free cash flow breakeven after paying its capex and preferred dividends. Nothing to brag about, but if Franklin Covey’s current management continues to do the right things from an operational standpoint , this is a company that can easily make $0.30-$0.50 on even a slight uptick in sales. This uptick is certainly tied closely to an economic recovery, but I am not certain that more costs can’t be wrung out if that doesn’t pan out.

Franklin Covey has certainly gone through a rough last 5 years as a company, but under its relatively new management, it is doing the right things to clean things up. Starting with shedding itself of non-core activities, selling peripheral businesses and outsourcing operation functions, Franklin Covey has paired itself down to a company whose primary function is to increase the productivity of workers in mid-to-large organizations. Its goal is to simply train employees to become more organized and better focused at their jobs. Ultimately, these training sessions drive the entire product sales process. This is where I think management has spent most of its strategic focus, not on its retail products, but its training products. On the training side, employers are convinced of the benefit of FC’s seminars, the employees attend them and then FC’s products are offered to assure that the principals taught are followed and retained. While not everyone finds the Franklin planning system wonderful, many do and many stick with it for years. PDAs were considered a big threat to this market, but recent results have shown that not to be a sustained threat. Paper is still preferred by a cohort of people out there.

What is Franklin Covey ultimately worth? It is tough to answer, but given that they have shed overhead and management has shown itself to be disciplined in its core business focus, if they can convert this into sales north of $350m (we are talking very minimal growth from $335m) they could easily be priced at $3-$5 per share (or 10x EPS). This would be a conservative valuation given that kind of turnaround. At a little over $1 per share, Franklin Covey is being looked at as a dead company and its recent drop is entirely trading/liquidity related. Fundamentals would justify a much higher price even given the perception of the company’s future.

Here are a few more points and rhetorical questions about the company that might help you in digging into FC:

1. What would the value of the company be if it discontinued it’s retail mall based division and sold its product only through its catalogue and website? My feeling is that this management isn’t wedded to anything that isn’t rational and anything is on the table.

2. The CEO, Bob Whitman came from and private investment group that owns the $87m preferred. He has distanced himself from the group from a day to day standpoint but is still a limited partner from my understanding. What is his primary motivation? Upon arriving at FC, he got 1.6 million options with a strike of $14, matching the strike on the preferred stock. They are not exercisable until 2007, but can become 50% exercisable if the stock reaches $20 and 100% exercisable if it hits $50. His salary is $500k with a bonus that is tied to primarily EBITDA. He passed up any bonus last year voluntarily from my understanding. He’s aligned with shareholders in my view.

3. The stock loan program is an assumed debt when the company paid off all its bank debt with the Premier unit sale. About 3.8m shares were purchased for around $33m and the company has reserved for loan losses of around $10m. The loans are not maturing until 2005 and the value of the stock underlying those loans is a little over $4 million. FC will need to reserve more (done automatically by formula). This is a non-cash item, but it doesn’t look good. I don’t expect that much of the loan will be repaid except by confiscating the 3.8m shares. So that is why I use the 16.1 million shares outstanding.

4. The preferred shareholders are in pretty good shape here, but I pose the question of what could the company do to renegotiate the preferreds to increase the common’s value? I don’t have a good answer for this, but I do find it curious that the preferred holders ok’d the near tender offer of 7.7m common shares last November-December at $6 per share. It was nixed at the last minute, word was FC didn’t like their sales numbers during those months and got nervous. Now that they have some confidence in their sales stability going forward, could another tender be in the cards? I don’t know. Would the preferreds agree again? The company told me they agreed the first time. What would they tender at? North of here in my view.

Catalyst

Selling for less than its net liquid working capital. Under massive selling pressure this week due to being eliminated from the S&P 600 index and around 1 million shares are in the process of being sold at what looks to be “at any price”. FC’s stock price has fallen recently from around $2.30 to about $1.10. This is just too cheap regardless of the perception that this is a crappy, outdated business. Longer term, management has been restructuring the expense side aggressively and strategic focus of its products