Description

Second verse same as the first (essentially).  Similar to my previous write-up this year in this is not an overly sexy story, but rather a story of an unsustainably low valuation.  Jennifer Convertibles is trading at a price that offers the opportunity for a 40% to 70% price adjustment gain by simply moving to a valuation that more approximates its peer group.  Further, given a recent strategic licensing deal, Jen-Jen (not Tom-Tom) could be at last poised to deliver significant gains approaching a double or better.

Kejag700 wrote up JEN last year at this time.  I reference his writeup as it gives an excellent historical background of the Company and the key players. 

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For the VICsters suffering from EOTYIO (“end of the year idea overload”) here is the quick version:

JEN is trading at a discount in the neighborhood of 50% to peer valuations.  The business has stabilized and is growing moderately organically with high returns on capital.  A recent licensing deal with Ashley Furniture HomeStores has the potential to significantly grow revenue and profits over the next two years.  So, 1) its cheap 2) it’s a reasonably good business, and 3) JEN has the chance to look and act like a growth stock at some point over the next two years.

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Background:

JEN operates the largest chain of sofabed specialty retail stores in the United States. Currently the Company has a store count of 191.  24 of the stores are licensed by JEN to a related third party.  These operations are not consolidated on JEN’s financials.  JEN’s stores are approximately 3,000 square feet.  The stores are efficient but by no means glamorous.  Maintenance cap-ex is a miniscule $600K to $1M per year on total revenue of approximately $140 million. 

JEN sells a complete line of sofabeds as well as regular sofas, loveseats, chairs and recliners.  The merchandise mix encompasses a wide range of design and quality to appeal to the broadest range of buyers.  I would characterize JEN as a “mass consumer” retailer as opposed to a “mass merchandiser.”  They try to appeal to all income groups with a defined product mix.  To handle such a wide product mix, JEN typically has the showroom filled with “representative” product.  So, JEN displays their wide variety of sofabeds, loveseats, etc. but typically does so in only one color and fabric.  Samples of other colors and fabrics are made available for the customer to individualize the product.  Thus, the store maximizes the real estate available and offers customers great selection and value.  As is typical, JEN also derives revenue from warranty and other product protection items. 

Financial Overview:

Well, that’s pretty uncompelling (until you see the valuation, anyway).  Of note, however, JEN closed a net of 19 stores (20 closed, one opened) in 2005 and closed 3 stores in 2006 (while opening 0).  In that light it can be seen that JEN has been making progress in rationalizing operations and driving more efficient use out of their advertising dollars in their successful markets.  2005 and 2006 also reveal that operating expenses are clearly under control as revenue growth has not led to a corresponding increase in SGA. 

Management:

The management team is seasoned and has been with the Company for a long time.  Yes, this could be the dreaded “entrenched” management issue.  However, given the age of some of the key players, I interpret the recent rationalization of operations as a sign of “fixing things up” prior to a realization event (either through a realistic valuation or ultimate sale). 

Valuation:

Using fully-diluted shares of 8.3 million (assuming full exercise of options, warrants and a convertible issue) here are the stats.

8.3 mil shares @ $5 = $42 million

Cash including exercise = $15 mil.

Enterprise Value = $27 million.

JEN is currently trading at:

EV/Sales = .19

EV/EBITDA = 4.5

EV/EBIT = 5.3

My peer group of a smattering of home furnishing retailers trade at the following average multiples:

EV/Sales = .5

EV/EBITDA = 7.8

EV/EBIT = 9.5

My peer group of home furnishing manufacturers/distributors trade at the following average multiples.

EV/Sales = .8

EV/EBITDA = 7.2

EV/EBIT = 9

As can be seen – the market currently is extremely negative on JEN.  However, as recently as late spring/summer JEN traded in the low $7’s.  At that price JEN would appear to be fairly valued based on its current operations only. 

Why the price slide?  Who knows.  But these are probably the risks - which in my mind have already been digested by Mr. Market: 

1)      Nano-cap year end sell-off,

2)      Investor impatience (overly focused on QoverQ eps numbers),

3)      Headline “negativity” hides stabilization of business (fourth quarter didn’t comp well to last year – but last year included store dispositions), or

4)      Comments made by the Company that there is the risk of near term economic softness. 

In any event, none of these issues are long term.  And based on a peer analysis I believe JEN rebounds upwards toward the upper $6 level yielding a return of 30% - 40%.

Further Upside:

Looking at some generic retail stats and JEN’s current stats you can run some numbers as follows:

90,000 sq. feet (3 stores at 30,000 sq ft) at $250 sales per square foot (JEN currently at $260) yields $22.5 million in incremental revenue.  Using a 30% gross margin (conservatively) that adds approximately $7 million to gross profit.  Assuming management is rational on SGA and allows only modest cost creep of 5% (after all the stores are in NY where the Company is currently located) that implies a $5 million increase in EBITDA.  Allowing for modest organic growth in the existing store base implies that two years from now JEN could be on a run rate of $12 million in EBITDA on $170 million in revenue.  Using an average of a 6x EBITDA multiple and a .5 revenue multiple gets an EV in the $70 - $80 million range.  That’s a meaningful move from the fully diluted $40ish market cap right now.  Granted, this is a “slow” opportunity not a quick catalyst – but a potentially very rewarding return for the patient investor. 

Risks:

Economic softness causes weak quarter(s).  (I view this as purely short term risk - and at 4.5x ebitda priced in)

Management loses focus on cost side as it expands into HomeStores.  (I view this as low risk given management's recent focus)

Catalyst