I am going to preempt this write-up by quitclaiming any defense of Martha Stewart’s compensation or corporate overhead.  There is no justification for either.  It is perfectly reasonable for any prospective investor to question her true intention; building a valuable business, or use MSO as a personal expense account to pay for  lavish perks.  Yes, the Company has taken some meaningful steps over the last two and half years to shed high-fixed cost legacy media businesses.  Gone is MSO’s TV business.  Gone are two unprofitable print magazine titles.  But more could be done.  It is astonishing how much equity value would be created if Martha cut her pay, abandoned her absurdly expensive non-productive lease in downtown Manhattan, and divested/restructured the remainder of her publishing business.  

            Buried amidst the debris of corporate waste lies the premier licensing business in the home products category.  A recently renegotiated deal with JCP brings to light just how cheap Martha’s licensing business is relative to the market value of the Company.  Her brand is an irreplicable franchise, gaining strategic importance to both physical and online retailers.  With no leverage, minimal capital expenditure needs, ~$.61 per share in cash and investments, and a Merchandising Business trading at ~3x core Enterprise Value, the current price demands a concerted effort on Martha’s behalf to destroy value.

MSO currently trades at $2.80.   On October 21st, MSO announced a revised, narrower licensing deal with JCP.  The new licensing agreement limits the scope of MSO-branded products that JCP can sell.  Presumably, the deal was done to help resolve the spat with Macy’s. 

            The most interesting part of the revised licensing deal is the “return” of 11MM shares of MSO stock that JCP owned in connection with the original deal with MSO.  JCP originally purchased the stock for $3.50/share in 2011.  JCP is now “returning” the shares.  Effectively, MSO tendered for ~16% of the shares outstanding. But instead of expending cash, MSO is exchanging its services.  If MSO believes its stock is undervalued (perhaps due to an action it might take in the near future), then the Company is giving up a lot less than it is getting.  In the press release, Martha Stewart remarked, “….there is a lot of value in getting our stock back.”  Curious choice of words for the Chief Creative Officer.  

            Shrinking the share count by 11MM shares brings the diluted share count to ~57MM shares.  At $2.80/share, this implies a $160MM market capitalization.  MSO has no long-term debt and combined cash and short-term investments of ~$35MM, for an Enterprise Value ~$125MM. 

            In 2008, MSO paid $50MM (~6.3x EBITDA) for the Emeril Lagasse’ media and merchandising assets (ex. restaurants).  Emeril’s business is non-core to MSO’s business and could be divested.  MSO does not break out Emeril’s EBITDA separately.  Emeril is still publishing cookbooks, has a cooking show on the Cooking Channel, and just released a new line of cookware with QVC.  Haircutting the Emeril business by 80% from the $50MM purchase price in 2008, gives the Emeril business a value of $10MM.  It is worth noting that this valuation could be low.  MSO bought Emeril at a time of distress in 2008 after Hurricane Katrina negatively impacted his New Orleans’ restaurants.  It is probable that the Emeril’s business has been neglected amidst the restructuring and struggles of the core Martha Stewart businesses over the last four+ years.  I would guess there are many buyers for the Emeril media assets.

            MSO also has a $124MM net operating loss as of year-end 2012.  Tax-effecting the NOL at 35% and then discounting it by 1/3 (naturally imprecise), would give the NOL a NPV of ~$14MM.  Reasonable people can quibble about whether MSO should get credit for the NOL, given its long-history of losses.  However, a strategic acquiror/partner would be determined to preserve the benefits of this tax asset, given its size relative to the market value.

            Stripping out the Emeril business and the NOL results in core-Martha Stewart EV of ~$100MM. The core Martha Stewart Enterprise Value includes three different businesses; 1) Publishing; 2) Merchandising; 3) Broadcasting.   Subsequent, to Martha’s exit from TV, the broadcasting business is mainly a digital business, aiming to monetize Martha’s brand online.  The business represents about only ~3% of E2013 revenue and is not expected to meaningfully detract or contribute to operating profit in the near future.

            Through the first nine months of 2013, the publishing business lost $13MM.  The publishing business has lost money for the last three years.  MSO is aiming to restore the publishing business to profitability.  In November 2012, MSO announced that it would stop publishing Body & Soul/Whole Living, and would transition Everyday Food from a stand-alone monthly to a five-times per year supplement in its flagship magazine, Martha Stewart Living.  In connection with the downsizing, MSO laid off 70 employees (12% of its workforce).  MSO is left with two titles: Martha Stewart Living and Martha Stewart Weddings.  Martha Stewart Living has been reduced from a monthly publication to a ten times per year publication. 

            The unfavorable economics of print make it unwise to discount any future contribution profit from MSO’s publishing business.  It seems that every media business that does not need to be in print is either divesting or spinning off print assets.  It is worth nothing that the subscriber lists for Living and Weddings are probably good assets.  The Martha Stewart Living magazine has a rate base of ~2MM, likely with demographics for advertisers.  MSO sold its Whole Living subscriber list in 2013 to Meredith for ~$1MM (the gain on sale was ~$2.7MM due to release of liability from deferred revenue).  In 2012, Whole Living had a rate base of 750,000.  The Martha Stewart Living subscriber list would command a higher price.     

            The Merchandising Business is the gem.  In 2013, Martha’s merchandising business should do  ~$35MM in operating profit.  At the current core Enterprise Value, an investor is creating the Martha Stewart Merchandising Business, the premier franchise in home products, at ~3x E2013 segment EBIT.  Here are the Merchandising EBIT figures going back to 2007:

2007: $57.2MM; 2008: $32.9MM; 2009: $25.7MM; 2010: $25.7MM; 2011: $30MM; 2012:  $39.5MM. 

            As online retailing grows, Martha’s merchandising business becomes an increasingly important strategic asset for physical retailers.  Bricks and mortar retailers need exclusive products to create buzz, drive store traffic, and defend gross margins (less markdown risk if the products cannot be found everywhere).  The home products and lifestyle category, Martha’s niche, is particularly crucial for physical retailers given that home products are less susceptible to the vagaries of fashion than is apparel.  Major home products tend to stay the same.  The unfavorable economics of shipping big-ticket home products also insulates against threats from online.    

            Likewise, online retailers will increasingly covet exclusive brands in order to build trust with customers who cannot see and feel products prior to purchase.  The imprimatur of a brand with a pedigree will be especially desired.  Martha Stewart’s brand is best-in-class.  Would it be surprising to see Martha do a big deal with ETSY, Pininterest, Amazon or Alibaba?  

            As a stand-alone entity, Martha’s merchandising business is worth multiples of the pro forma market value.  The licensing business requires little capital expenditure, working capital, overhead or leverage.  Kathy Ireland runs a ~$2B (at retail) home products licensing business with 42 employees, without a fancy Manhattan office.  At year-end 2012, MSO had 497 employees. 

              At 10x E2013 Merchandising EBIT, MSO’s merchandising business would be worth ~$350MM.  I think it is worth much more.  Martha’s brand is underpenetrated in luxury, furniture, and international retail.  Her EBITDA margins in Merchandising should be higher.  Large, well-run licensing businesses can do 75-80% EBITDA margins; through the first 9 months of 2013, Martha’s merchandising business is doing a ~65% operating margin.

              A disciplined partner/owner (Iconix) could strike more deals and improve the margin profile.  Iconix routinely pays 10x EBITDA for less compelling brands than Martha Stewart.  Even if JCP goes bankrupt and Martha loses that deal, another suitor will beckon.  This has been true since her first deal with K-Mart.  Consumers, old and young, simply don’t care about her insider trading, stock price, or soured corporate partnerships.  Her style and craftsmanship win the day.   

            There are two competing narratives with this stock.  Narrative 1 says that Martha is content to run her company like a personal piggy-bank.  With corporate overhead fixed at around $35MM and publishing structurally challenged, the business will never grow into the valuation.  It will continue losing money.  Magazines are the ultimate vanity plate.  Martha would rather see her name on the banner than make the economically rational decision of shrinking/outsourcing the publishing business.  The Company will systematically burn through its cash as it continues subsidizing print losses in the name of ego.

            Narrative 2 says that the great recession, coupled with the acute disruption to traditional media ushered in by digital advertising, upended MSO’s historical  business model.  Slowly, MSO has adapted by shrinking its legacy media businesses.  In coincident, the growing importance of exclusive brands has made Martha’s name more valuable.  The fact that MACY’s extended their deal with Martha through 2017, despite CEO Terry Lundgren’s contempt for her behavior, is proof positive of her importance.  Macy’s simply could not afford to let her go somewhere else.  More licensing deals, forged on better terms than the original MACY’s deal (struck subsequent to her release from jail), will follow.  MSO will be able to secure better terms in the form of guaranteed minimum royalties and upfront payments.  Martha is tired of watching her net worth migrate south while the rest of the ladies who lunch at the Bedford yacht club reap a windfall in their stock clubs.  Her recent tender for the JCP stock was a shrewd move at the expense of a motivated seller.  The disconnect between asset value and market price will be too great for Ms. Stewart to ignore.  

            The bet is that the second narrative will prevail.   If that should prove wrong, it will quickly show up in the numbers, specifically continued losses in print.  Then, there should be room to exit without too much pain.